How many losses in a row?
- Thread starter CheckM8t
- Start date
I have a rule where if I have 3 losing trades in a row, I shut down for the day. I also have a rule for maximum monetary loss per trade/day. It helps 
The specifics of a system are important to answering your question. Different strategies for trading will entail varying numbers of potential losses without necessarily invalidating the process in any way.
Take trend-following as an example. I know of four proven methods of entering a trend on a pullback:
1. As price is pulling back and comes within 50% of a key level that should hold as S/R (a trend line or a 20-period moving average, for example) you begin averaging into your position until the key level is reached, and place a stop loss at a breach of the key level. This method ensures you have at least a partial position on when price turns back in the direction of the trend.
2. Place a limit order inside the key level that should hold as S/R, and place a stop loss at a breach of the key level. This method ensures a "best value" entry if your order gets lifted, but in a strong trend, you may be left behind with no fill.
3. Trail a stop order just above/below the close of each pullback price bar in your time frame to enter a position in the direction of the trend at the point price reverses with enough conviction to sweep you into the trade in the direction of price momentum, and place a stop loss outside the pivot price level or other key level that contains the trend.
4. As price is pulling back and approaches a key level, place a limit order a fixed number of ticks above/below the previous pullback bar's high/low, and place a fixed tight stop loss on each attempt to catch the trend continuation turn, until you're positioned and price resumes the trending move, or the key level is breached.
The first three methods should result in very few back-to-back losses if you're trading a defined trend (not a wide range or indecisive chop).
The fourth method is a "fly fishing" entry strategy where you may have three or four small losses before catching the continuation turn. So the fact you have three or four losses in a row doesn't mean you're trading badly and should quit, it means you're following your trading plan and once you catch the turn, the profitable move renders the losses meaningless in most cases.
If you're chalking up losses as a result of violating your entry strategies or trade management plans, then two in a row is too many, IMHO, and you should take a break and regroup.
The basic formula for figuring the expected maximum losing streak is:
S = ln(1/T)/ln(L) where:
L = % losers
S = Streak
T = # trades
Ex.
T = 500 trades
L = .6 or 60% losers
S = ln(1/500)/ln(.6)
S = -6.21461/-.51083
S = 12.16581 or a expected max. losing streak of 13 trades
If you increase the number of trades to 1,000 then:
S = ln(1/1000)/ln(.6)
S = -6.90776/-.51083
S = 13.52273 or a expected max. losing streak of 14 trades
confidence level is 1 - (1 / number of trades)
ex. 500 trades = 1 - ( 1/ 500) = .998 confidence level
Of course you could lose on all trades (there are no guarantees in trading). You could use this to plan cutoffs and use it to check normal vs abnormal losses.
Alan
S = ln(1/T)/ln(L) where:
L = % losers
S = Streak
T = # trades
Ex.
T = 500 trades
L = .6 or 60% losers
S = ln(1/500)/ln(.6)
S = -6.21461/-.51083
S = 12.16581 or a expected max. losing streak of 13 trades
If you increase the number of trades to 1,000 then:
S = ln(1/1000)/ln(.6)
S = -6.90776/-.51083
S = 13.52273 or a expected max. losing streak of 14 trades
confidence level is 1 - (1 / number of trades)
ex. 500 trades = 1 - ( 1/ 500) = .998 confidence level
Of course you could lose on all trades (there are no guarantees in trading). You could use this to plan cutoffs and use it to check normal vs abnormal losses.
Alan
This gives the max losing streak, but is there any formula for the probability of further losing streaks? E.g. you lose 13 in a row in your example above, then win 1, then another 10 in a row or whatever. Seems like this formula you gave would underestimate the risk.
Or is it necessary to just do lots of Monte Carlo simulations?
I guess what you're asking for is a formula for estimating drawdowns assuming a normal distribution of returns. You can estimate the probable ending returns using statistics and your sample trades. But other than using Monte Carlo runs I don't know of a way of estimating probable drawdowns. I may have research work in my notebooks so I'll search through them to see if I have anything that may be useful.
Alan