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The goal of every trader is to increase the equity curve somewhere between these two extremes, and to do so as quickly as possible. As you might imagine, this is rarely an easy thing to accomplish. As the equity curve becomes steeper, the amount of risk that the trader's equity is subject to increases, and the faster that equity will increase. As the equity curve becomes less steep, the less the trader's equity is subject to risk, and the slower that equity will increase. |
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It is a mathematical fact that a 20 percent loss cannot be made back with a 20 percent gain. For example, if you have $100,000 in your trading account and you lose 20 percent, your equity will now be $80,000. If your gain in your next trade is 20 percent, your profit will be $16,000, giving you $96,000. In order to return to your initial equity amount of $100,000, you need to have a gain of 25 percent. |
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The mathematical formula to determine the percentage required to recover from a loss is: |
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Figure 18-5 depicts the various outcomes graphically. For example, if you lose 50 percent of your equity, you will need to have a 100 percent gain. |
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It becomes painfully obvious that a loss of 50 percent makes it almost impossible to recover, since it would take a profit of 100 percent to return to the beginning point. Lost money is always difficult to recoup, because margin requirements and risk management make it ever more difficult to recover from a large drawdown. Every trader has to realize that it is much easier to lose a certain percentage of equity than it is to make it back up and get back to the starting point. This is why risk control and money management are critically important. |
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Although it sounds impossible, always remember this simple truth: Proper risk management techniques will dramatically increase profits of a marginally good trading methodology; alternatively, an outstanding methodology will lose money if no risk management is practiced. |
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