Going the Conservative Route (Step 6)

July 8, 2020

We recently decided to embark on a journey to beat the market.

To do that, we decided to start from scratch. 

Our goal is to build a system that will easily outperform the market over time and build this system step-by-step so anyone can follow along. Feel free to ask questions as we go. 

To review, here’s what we’ve done so far:

1. We chose Forex over stocks and futures for the leverage and because we can trade any size account;
2. We picked a system that suits our psyche (buy-low-sell-high) so we wouldn’t get discouraged, and then did a quick run-through of some numbers to see if it’s profitable;
3. We chose one of the most popular currency pairs (EURUSD);
4. We used ATR to build a hypothesis on how our system could work;
5. We calculated a legitimate trade size we could use.

We have a sensible methodology, a pair to trade, an idea of what parameters might work.

We also now know that the maximum trade size we could use on a hypothetical $10k account is 4.4 lots.

The question is: should we trade that much? Is that size dangerous or just right?

Let’s take a look at the numbers.

If we are marginally conservative and don’t want our first trade to get rejected due to lack of margin, let’s run a test using slightly less than we think we can use. We’ll use 4.3 lots (just under our max).

Here’s what how that turned out:

Whoa, we made $280,046 of profit! We’re rich!

Unfortunately, we’re not. See the Maximal Drawdown number? It’s -$32,830. That’s the worst losing streak we had over the testing period of 2008-2020.

At some point before making $280k, we would have exceeded our account size of $10,000. So what do we do?

First, we’ll take the conservative approach.

Let’s say we just want a system to set-and-forget. We never want to worry about this account.

If so, then all we have to do is cut that max drawdown down to a number we’re comfortable with. How about 25%? I think we could handle a 25% drawdown. The market goes down that amount all the time.

A 25% worst drawdown means we need to get it down to $2,500. At 4.3 lots, the drawdown is -$32,830.

If we divide our max drawdown by 13, we get a new max drawdown number of -$2,525. Great!

Now all we have to do is divide our original trade size of 4.3 by 13 and we get a new lot size of 0.33.

If we run the test again with that size, we get this:

Mission accomplished. Our max drawdown is just as we thought: -$2,525.

Of course, our profit is way down also, but that’s the trade-off. We’re exchanging life-changing profits for being able to sleep peacefully.

We now have our conservative trade size.

But what if we don’t like peaceful sleep? What if we are the aggressive type?

Get on the email list to find out.

Talk to you soon.

To get the whole series of emails on Starting From Scratch, join the free email Newsletter list here.

To get on the email list, go here.

To become a Member go here.

Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.