A member of my mailing list asked me this question about trading system performance:
For the systems I have tested so far, the equity line shows a significant drawdown at the beginning, but the system later recovers from that initial loss, in a kind of J-curve. This could be due to the specifics of the system, but I was wondering if this is a normal pattern in most systems, in which case my question is what is the rationale for this behavior in the equity line.
The formation and pattern of trading system equity lines will vary based on two primary things. One is obviously the way the system is trading. The other is what the market in question is doing at the time.
I would definitely not call it “normal” to see a J type of pattern to the equity line. If that sort of thing is being seen repeatedly in one’s testing then it suggests to me that the systems in question are of a certain style, but that the initial part of the price data being used has a pattern which is not beneficial to that style. For example, the systems being tested are of a trend trading nature, but the price data in the early part of the set is actually mostly range-bound. That would create a series of whipsaw trades, and thus a drawdown at the start of the equity curve, with things then improving later on when the data became more trendy.
If you are experiencing something like what the questioner has described, try testing your system with a different start point in the data. That should change the pattern of the equity line.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
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