Gentle equity curve or rollercoaster gains?

Methods like DIBS are kind of "brute force" strategies. You enter over and over and over again because statistically (so I'm told) eventually you will score the "long tail" that gives you the profit, the edge. In the meantime you wait weeks or months or years as the account suffers potentially large drawdowns or meanders sideways. Psychologically, this is the killer for so many traders. We are unable to wait. Moreover, we are worried that we will miss the winner when it happens because we took our holidays that week or month, or just panicked and exited because we'd lost faith in the system just when it was ready to pay us for our perseverance.

If I could have the choice, I think I would prefer a system that gave slow and steady gains, rather than one that offered big payouts from time to time, perhaps months or years apart. Even if the former meant the gains would be smaller than the latter.

Most who trade forex are under-capitalized. These are the people most vulnerable with systems like DIBS. If the returns aren't steady, it can become a simple battle for survival, mentally as well as financially.

So basically my question is - is it necessary to consider large drawdowns and large timeframes as the only means to success? The larger the drawdown you are able to tolerate, the greater the likelihood you will witness large gains at some point down the track. How often do you "cut your loser short" only to see it resume its original trajectory after horsing around for a few days or weeks? Or is it possible to grow steadily and surely without the need for large drawdowns and large timeframes? Help Bob make some money.

Bob

There is a chart somewhere on this forum which indicates the likelihood of x consecutive losers given a system with y% win rate. Even if you have a system with a high % winners, there will be losing streaks, where you can lose 10-15 times in a row. This is fairly common.

So, whatever strategy you choose, you must be prepared for a streak of losers. I know this isn't what you wanted to hear, but it's the fact. This is why the pros suggest using a very small % risk of your account. I'll try to post a link to the chart as soon as I can find it.

Yes, I would definitely prefer a slow and steady curve. I think everyone does. Even on the DIBS thread, it was suggested to take half off at 1:1 to smooth out the equity curve. However, it's not possibly to predict the losing streak. It's only possible to be prepared for it.

Reading your post, I feel like you're still looking for a good "system". May I suggest the j16 and no brainer threads? I'm sure they'll help you find what you're looking for.

Everyone has different ways of managing their trades. I think most people would prefer to cut losses rather than take a full loss in the hope of a big winner. In the j16 thread, you'll find that some traders move their stop to BE when the trade's moved a bit in their favour. Some take half off at 1:1. It's really up to the individual trader.

"The larger the drawdown you are able to tolerate, the greater the likelihood you will witness large gains at some point down the track."

I will post a link to that chart. Regardless of system, the ability to sustain a large drawdown is essential to survival.

Probability of x successive losing trades within a 50 trade period:

http://www.forexfactory.com/showpost...3&postcount=56

I have the feeling the percentages mentioned by "professional traders" often are statistically inefficient. I'm referring to the people stating you shouldn't risk more than 1-5ish percent per trade.

Assuming you have some sort of edge, you will probably make a lot more money trading much larger percentages in the long run. Vince Ralph has written a nice book on this subject, called Mathematics of Money Management. I believe he even claims that the better the system, the higher the optimal f (google it if you want to know what it means), the greater the drawdown.

I haven't read the entire book yet, but so far the main things that worry me are the risk of ruin (which occurs at the point where the loss is so great that its impossible to recover, for example by not meeting lot size requirements anymore), and the chance that a cyclical nature exists in a trader's edge (for example that a system is more profitable in for example bull and bear markets than in range markets, and that these market conditions can hold for a significant period of time, while the system keeps giving signals).

Of course, there is a large psychological/emotional pressure when you lose 30% in one trade, compared to when you lose 3%, so from that point of view risking a low percentage might be better indeed.

Great question Bob, and one I have asked myself many times in the past myself. As a dibs trader that has seen huge gains and huge draw downs I agree this is very hard to take. I must admit I enjoyed the great gains but found the draw down just too hard to bear. How does one know when to cut your losses as you ask, this is the big question I suppose.

I have two suggestions that I can think of and the first would be to diversify, from what I have read most professional traders trade many markets and from what I can understand they diversify among multiple uncorrelated markets. This generally will smooth out there equity curves as when one market is not doing so well some of the others will be performing and thus balancing things out.
This becomes difficult as you say as most of us trying to get ahead are just too under capitalized and don't have the funds to handle this size portfolio.

Secondly I can only suggesting some serious back testing. Now this is a massive time investment but probably the best investment you could make. I personally have stopped trading and have spent the last month back testing and feel I will have many more in front until I get to where I want to be. The advantages here are I am not losing any money at the moment and once I have proven my method over ten years of data I will have the confidence to trade it. I will also have a realistic Idea of just how large a draw down the system has delivered in the past and thus manage my risk accordingly.

I think a reason that most people don't do this back testing is it is just so difficult and time consuming. I know I use to come up with every reason why not to do it and why its no use. BUT when your trading a system and do go into a deep draw down you have absolutely no Idea how deep it will go if you don't have years of previous experience trading the said system. This is the part where we probably all bail out just prior to the system kicking back in. I guess the pro's know this and DO know what to expect and have experienced it in the past and have the tenacity to stick with it and trade right through it to new water mark high's.

I personally have traded up plenty of profits plenty of times but then traded it all down into losses, its always at this point I keep telling myself that this is the way it is and accept it. But when you just keep bleeding you eventually get to a point where you have to say where do I cut my losses and bail. You know is this 30% or 50%....., I don't know but I can say that trading through a 50% draw down is tough, very tough. I am yet to do it succesfully but do find it very hard psychologically. that is where if you have all the previous data you have a much better chance of survival as you have some idea as to what sort of returns to expect and also what sort of draw down to expect. With this information you can then adjust your risk parameters accordingly and thus make it a bit easier to handle.

Sorry to rabbit on so much but hope this helps.

Trade well
Perry

There is drawdowns to every system. If you start with a small account the issue is that you don't have capital to withstand moves to go against you too far... could be the main reason most traders reduce to scalping for their initial trading with the mentality to benefit from the small moves and keeps stops tight.
I am not saying that scalping is not profitable but when you are starting as a new trader it could be very damaging due to lack of knowledge.
When it comes to bigger timeframes you would need to have a bigger account to withstand market moving against you for a longer period of time.

You need to master your methodology and test it with the timeframe you like most, usually the timeframe you choose will suit you best as person/trader. Once you find out more about yourself and what you want from the markets at some point you will stop thinking and allow your own rules to trade for you, your account will now grow much faster as you increase your contract size, hence your equity curve.

Yes, Looong term traders can and do make money. A .10 pip per $10,000 in equity should let you sleep pretty comfortabley at night. But you must also have the patience of Job, and bring your profit expection in line with reality. If this is to not to your liking, then you have the option to become a short-term or "day" trader. No matter what strategy you employ as a day trader, you must become a student of streak theory. Even if you have a winning system, you must be prepared for a long streak of losing trades. Prepare for it, expect it, because it will happen. Forget about simple probability theory-- it is pretty much useless as it pertains to streak theory. Start thinking about the Probability of probability. This will start you down the road to a plan to withstand the bad streaks and come out fighting on the other side.

Kindest Regards,

Thanks all for your responses. I see the big picture a lot better now, and still like the idea of DIBS. But I have another question now on money management with DIBS...

To use a crude example, let's say I have a 1k account. An inside bar presents itself and meets the DIBS criteria. Let's say it it is around 20 pips so I buy 1 minilot, risking about 2.5% when spread is included. Then price runs 500 pips before looking to retrace or reverse. Now on the DIBS thread, the idea is to maintain the current stop loss, the long tail, rather than run a trailing stop which increases the risk of being stopped out prematurely. However my account is now 1.5k. If I allow price to stop me out at my original stop, have I not just blown 1/3 of my account? Shouldn't I be running a trailing stop that will keep any loss consistent with 2.5% of my account or whatever limit I'm prepared to risk on my equity?

Any comments appreciated.

I'm with you. I'd rather have a smoother equity curve than a wavier one.

One of the many big debates out there is "should I scale out or not?" I believe that *if* you have a good system with a statistical edge and positive expectancy (they're probably the same thing LOL) then scaling out is a good idea.

On the plus side, scaling out addresses 2 concerns that traders have:

1) Fear. When a trade moves in your favor, you begin climbing the so-called wall of worry. You get scared that your profitable trade might turn into a loser.
2) Greed. When a trade moves in your favor, you want it to keep moving in that direction and give you that long tail return.

When you scale out, you reduce risk which addresses fear. You've banked some profits and feel relieved. A common strategy is to not only cover part of your position, but to move the stop closer. I personally do the "sell 1/2 and move the stop to breakeven" thing.

Once you've reduced risk and taken some profit, you still have part of your original trade going. If you've moved the stop to breakeven, this remaining part is essentially risk-free, kind of like a lottery ticket. You're positioned to take advantage of the long tail if it happens. Trailing the stop some distance away allows it to run.

The detractors of scaling out say that if the trade goes against you, you're stopped out at the full trade size. This is correct, but as I said before if you have a system with a statistical edge, you know this will happen sometimes and can account for it.

Here are 2 books I have on my shelf that talk about these issues and they're both excellent:

"Trade Your Way to Financial Freedom" by Van Tharp
"Trading in the Zone" by Mark Douglas