How Do I know if I have a Strategy with Positive Skew?

You can do this visually without having to understand statistics. Positive skew means that your average winners are greater than your average losers and you are trading the right hand side of the Distribution of Returns to catch the positive outliers.

Have a look at the realised (blue) and unrealised (green) equity curve below produced with MT4 strategy tester.

Notice how the green line (unrealised equity curve) sits in general above the realised equity curve. When it strays below the realised equity curve (blue) it hugs the realised curve closely. This is because we always cut losses short when trading for positive skew.

When the unrealised equity curve sits above the realised equity curve, it can significantly outperform for periods of time. For example have a look at trades 249 to 274. This is when the EURUSD had a magnificent bear run in early 2015 and we took a ride with a trend following technique deploying short trades. Unfortunately we always need to give back some of this profit when the trend bends hence at the end of the trend, the realised and unrealised equity curves meet.

This visual clue using the realised and unrealised equity curve is symptomatic of divergent strategies of a trend following nature. With a trailing stop condition applied to your strategies, you will never exceed the unrealised equity curve. You always give back some profit to the market. This is the nature of trend following. However a trailing stop condition does assist in locking in most of the profit along the way in your unrealised equity curve.

With strategies of negative skew, you will find the reverse occurs. The Unrealised equity curve can sit well below the realised equity curve. This is a symptom that the strategy is warehousing risk and is likely to end in tears over the long term.

For example look at the equity curve below of a Martingale progression.

Look at the beautiful ascending blue line that makes it appear thay you have a perfect system….but then closely look at the green line (unrealised curve) to see what is really going on. See how the risk is being warehoused? If you are looking to purchase EA’s based on their realised equity curve performance, you could fall into the classic ‘negative skew’ trap.

Now a lot of shonky salesmen out there know how to window dress their performance metrics to create the appearance of a ‘holy grail’ but now you know a simple visual technique to sort the wheat from the chaff. Demand to see the unrealised equity curve of EA performance if all you see is a curve of realised equity balance.

Trade well and prosper

Rich B

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