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What is equity
Golden rules to evaluate a trading strategy just by looking at the equity line
According to Investopedia equity is the value of an asset less the value of all liabilities on that asset. So, what is equity? Just Assets minus liabilities. When we think of an investment, it is really important to know the amount of your equity and whether it has increased or reduced along the time. An algorithmic trader has to analyse its equity line periodically, even more than its own trading strategy.
Equity line is the mirror of your trading system
How to use your equity in order to evaluate your trading strategy? Here my rules to evaluate a good (or bad) strategy looking at the equity line:
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First thing to consider is whether the slope ispositively or negatively inclined. Chart on the left side is profitable, while the one on the right side is loosing money. Of course the former chart is better than the latter one.
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Second important information that I get from my equity lines, is "smoothness". The more a curve is sweet and smooth, the better a trading system is. The left side graph is better than the right side one, because it rises linearly, without the jumps the right graph faces. Even if both of them earn money, the left one is favourite.
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Third: Last trades are more important than older ones. A drop of the equity line in the most recent data may indicate loss of reliability in your trading model. So it is preferable the left side curve to the right one.
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Last but not least, a 45° slope (or even more), is preferable to a flatter one. The bottom right side slope is to be considered better that the left one. Such a slope is to be considered really good, because it is positive, has got a good smoothness, it is still working (even for the last tests) and has got a good tilt(around 45°).
