Monitoring Equity For Market Analysis
by Joe Luisi
STOCKS & COMMODITIES contributor Joe Luisi presents a strategy for using a graph of your profits and
losses to pick either trend-following or a trading range trading system.
It is well known — or it should be — that every trader should plot equity to see graphically how their
trading results are faring. But what may not be as well known is that traders can actually use equity as an
analytical tool. Equity analysis can indicate whether the markets are trending or trading sideways and
what approach a trader should use.
The basic approach to using equity as an analytical tool is to apply two trading systems: a trend-following
system and an oscillator-based one. When the markets begin to trend, the trend-following system will
perform well and the system's equity will rise and eventually move above its 25-day moving average as
the trend increases. Conversely, the oscillator system will perform poorly, getting whipsawed and
encountering a series of losing trades, which in turn causes the equity to decrease and eventually fall
below its 25-day moving average.
By tracking the equity, a trader can invest more capital into the system whose equity is above the moving
average and ignore signals from the system whose equity is below the moving average. Monitoring equity
will ensure that a trader will utilize the system with favorable performance and avoid the trading system
that is underperforming. When both equities are below their moving averages, a trader can then take no
signals at all and instead wait for the equity to rise above the moving average.