A trader\'s money management system

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c12 JWBK182-McDowell April 25, 2008 16:15 Printer: Yet to come

124 A TRADER’S MONEY MANAGEMENT SYSTEM

Trade Posting Card for October 11, 2007,

$1,451.64 Profit

Comments: The student notes, “...Market posted a bearish divergence be-

tween price and PO. Price reached Fibonacci Extension between 1.000 &

1.618 (n1586.75), which usually I have found to be a resistance. On the

5-minute chart a bearish Pyramid Trading Point was posted...this one

was one of my best executions this year I think...” (See Figure 12.14 and

Figure 12.15.)

THE ULTIMATE SCORECARD

The ultimate scorecard shows you what your profitability is by stating your

win ratio and payoff ratio and more. See Figure 12.16 for a quick look at the

annual scorecard of my trading students numbers. You will find it useful to

keep a scorecard on your own performance. Use the scorecard form you

will find in Appendix B.

PLOTTING YOUR EQUITY CURVE

It is useful to plot your equity curve to see how steady and smooth the

growth is. The smoother your equity curve is the better. For our purposes

we will briefly cover the topic of equity curve analysis so that you can see

the value of plotting your actual numbers.

For a more in depth look at equity curve analysis, you will benefit from

Tushar Chande’s bookBeyond Technical Analysis, 2nd ed., Chapter 6. He

goes into great detail about the SE or standard error aspect of your curve

and how that can impact your profitability.

In Figure 12.17 you can see a perfectly smooth hypothetical example

of an equity curve for a trading account that started with a $25,000 value on

January 1, 2007. This graph has been drawn to show a hypothetical $1,000

increase in equity every month for 12 consecutive months. As you can see,

the curve is actually a straight line that reaches from the bottom left corner

to the upper right corner of the graph.

Tushar Chande would consider this equity curve to have an SE, stan-

dard error, value of 0 or zero because it is a perfectly smooth curve. In real-

ity this curve would rarely, if ever, exist for a trader. A normal equity curve

will ebb and flow like the market does, three steps forward, one step back

and so on. What Chande explains is that the more ragged the equity curve