What Your Equity Curve Says About You

When it comes to reading your own equity curve, it tells a story about who you are as a trader. It reflects your level of volatility and risk-taking. A common rule in the financial markets is:

• Higher Risk (More Volatility) = Higher Returns / Higher Losses

• Lower Risk (Lower Volatility) = Lower Returns / Lower Losses

There is no way around this simple correlation. You cannot take big risks without exposing yourself to big losses, and, conversely, you cannot take lower risks and expect large returns.

The Story

In the simple chart demonstrations, two traders are showcased: 

• Trader 1 started out far ahead of Trader 2. However, the steep spikes in Trader 1’s equity curve indicate higher volatility and bigger risks.

• Trader 2 started out slower but has a smooth, consistent equity curve, reflecting a more calculated approach with less volatility.

Trader 1’s equity curve shows success driven by big gains, as indicated by the sharp spikes, which also signal higher volatility and risk-taking.

• Spikes = Taking on more volatility/risk for the chance of a big return

Trader 2, on the other hand, has a steady equity curve trending upward. This indicates a lower-volatility trader focused on consistency, taking trades aligned with data and calculated risk rather than attempting to time the market perfectly or chase large returns.

By the end, both Trader 1 and Trader 2 reached the same equity level. While Trader 1 outperformed at times, their volatile approach carried the risk of blowing up their account.

This is critical to understand because your equity curve tells a story about your trading style. Are you a volatile trader who takes big risks for the chance at big returns? Or are you a consistent trader who carefully calculates risks and manages positions appropriately?

In the markets, you can’t control whether you’ll make a profit on every trade. However, what you can control is calculating potential downside and setting up pre-determined risks on every single trade.

Conclusion

This was a short write-up for today, but one that I believe, though brief, provides a strong statement about the two types of traders: those who lack a good understanding of defined risk and those who understand, calculate, and implement risk management within their execution.

You should always ask yourself, “What are the risks to this position?” This doesn’t mean you should avoid taking the trade if there are risks—there are always risks in everything in life! Instead, it means structuring your trade in a manner that acknowledges and accounts for the risks you’re taking on.

As always, stay safe, manage your risk, and remain consistent! Hope you all have a great week, and be cautious with CPI news on Wednesday!

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