What is an equity curve?
An equity curve is a visual representation depicting the performance of an investment or investing strategy over time. An equity curve is usually plotted on a graph, with the y-axis showing the account value and the X-axis showing the time elapsed or the trade number.
Some investors use equity curves as a quick and simple way to assess the effectiveness of a trading approach. If the graph is trending upward, it indicates a positive return and a potentially successful strategy, while a downward sloping equity curve represents a negative return.
Here’s an equity curve example and more about how to use an equity curve to trade.
Example equity curve and calculation
Let’s take a look at an example of an equity curve and how it works.
Say your account of $10,000 had these seven trades below. The X-axis depicts the trade number and the Y-axis shows the account’s rolling sum.
| Trade Number | Trade result (profit or loss) | Account cumulative sum |
|---|---|---|
| Start | $10,000 | |
| Trade 1 | $1500 | $11,500 |
| Trade 2 | $100 | $11,600 |
| Trade 3 | -$200 | $11,400 |
| Trade 4 | -$100 | $11,300 |
| Trade 5 | $600 | $11,900 |
| Trade 6 | $400 | $12,300 |
| Trade 7 | $300 | $12,600 |
How is an equity curve useful for trading?
Investors can use an equity curve and the account value’s moving average to help with trading decision-making. The relationship between the moving average and the account value can help show you whether a trading strategy is working.
For example, if the equity curve falls below the moving average, you could stop using the strategy. Once the moving average meets or rises above the curve, you could start again. This practice is sometimes called “trading the curve.”
You could also use two different averages to track changes in the portfolio value and help with decision-making. For example, these figures could include the fast-moving average and the slow-moving average, or the simple average and the exponential average, depending on your analysis parameters.
However, it’s important to remember that moving averages have built-in lags and can be skewed by large swings in the market.
Bottom line
An equity curve can be a helpful visual tool for tracking account performance. It’s one of the many options investors have for analysis and can be used with other metrics to turn investing strategies on or off.
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