Sunday, September 28, 2014

The reality of a losing streak

As the various metrics and graphs here show, performance has been pretty poor over the last four months or so.

The reality, however, is that you have to accept that markets move from trending to non-trending phases. In that period, the markets have continued to show a potential disconnect, even if some are at or close to all time or multi-year highs. Market conditions have not been favourable for my particular style of trading, and my preferred timeframe, for most of the year.

No one like a run of losing trades. Yet they have to be expected.

Suppose you have a method that over a long period of time has a historical win ratio of 40%. So, on a sample of the next 100 trades, you would expect to have 40 winning trades. What you don't know is what order the winning and losing trades will appear. In the most extreme example, it is mathematically possible that the first 40 trades in that sample will all be winners. You could then suffer a loss of 60 trades in a row. Or, you could have 60 losses in a row to begin with, followed by 40 winners.

How would you deal with those two scenarios, both emotionally as well from a risk control point of view? You've still hit your historical average of a 40% win rate, yet over those 100 trades you would have suffered an emotional rollercoaster.

The other point to consider is the size of the average wins and average losses. The calculation using all these numbers with the win/loss ratio determines the overall expectancy of the system.

As things stand, the average expectancy number has remained pretty constant over the last year or so, although there is no doubt that it was higher four months ago. The goal remains to cut losers quickly and let profits run. So far this year, the wining trades have been infrequent, yet due to some big trends, they have been bigger (in terms of R) than all the small losing trades.

The trades list shows the run of consecutive losing trades is higher I would like, but is within what can be expected. A good trend follower will also know that one winning trade can eliminate all those small losses.

The consolation is that, despite the lack of performance over the last four months, the returns for the current year to date are still over +40%. Given the market conditions, I'll take that.

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