Automated Breakout Strategies for Small Accounts

People often ask me if breakout strategies can be used for small accounts. And the simple answer is, yes, they can. Today, let's have a closer look at this topic and how it can be done.

First of all, it is important to explain one crucial context. If you would like to create breakout strategies for small accounts, you need to work with a low risk. But everything costs something. A low risk will practically always lead to some compromise - mostly you will make less and the stability of your equity will be lower. But, you will experience longer periods when your account will go mostly sideways. Unfortunately, in trading there aren't black and white solutions, and each advantage is redeemed by certain disadvantage. Once you decide to build strategies for small accounts, you have got to ask yourself: What is more important to you? Is it a small risk per trade or a drawdown that is the smallest it can possibly be? (And don't say both, as these are contradictory. Why? I will explain that in examples.)

Drawdown vs. risk per trade

There is a general rule in breakout strategies - the bigger stop-loss, the smaller the drawdowns. Maybe it sounds inconsistent, but the logic behind is pretty clear: Breakout strategies have a tendency to go through substantial corrections throughout a day and a bigger stop-loss will cope with this much better. You risk less with small stop-loss, but you will be out with loss more often. A bigger stop-loss will help you to stay in during corrections. So, even though each loss will be a bit more painful, the overall drawdown can be smaller and the profit and success rate much higher.

Let's have a look at one of my simple breakout systems which can be used to trade on numerous markets even with a small stop-loss.

In this system, the smallest acceptable stop-loss value is 100 USD (market EMD, 30-minute timeframe). It is possible to use the same stop-loss in ES or TF markets with similar results. Such stop-loss is indeed very low for automated trading strategy - quite often even smaller than in similar markets during discretionary trading. With a stop-loss like this, it is possible to trade a small account and losing trades won't be considerably unbearable.

How would equity and maximum drawdown look like with this scenario? The system is generating stable profits, but equity has its weak periods. The average profit is 3000 USD per annum and overall drawdown is 2380 USD. It means it is possible to trade with a very small stop loss. However the question is: Wouldn't it be worth to increase the risk a bit? I understand that for someone with a small account a stop-loss higher than 100 USD could be unacceptable, but let's see if we wouldn't actually gain more than if we used a very small 100 USD stop-loss.

And now the same system with a stop-loss of 300 USD. It sounds like a big jump to increase stop-loss to 300% of the original amount, but let's have a look at what we have gained. The average profit per annum increased to approx. 4200 USD (a 40% improvement), the stability of equity is considerably better, and drawdown decreased to 1930 USD (almost a 20% improvement).

So, the first rule when searching for ATS breakout strategies is: Even if you are working with a small account, search for a strategy with a slightly bigger stop-loss than you would normally use in discretionary trading, or a bit bigger than you would feel is acceptable.

In this case you have to perceive stop-loss only as a necessary protection. Even though individual losses will be more painful to some extent, your results will improve and profit distribution will be more stable.

How to capitalize

Once we have a system with relatively small risk (300 USD is still a very small stop-loss; I personally also work with stop-losses of 2000 USD per contract) and a small drawdown (drawdowns of under 2000 USD for an automated breakout strategy can be regarded as small), for such strategy we can capitalize with a relatively small account. The technique is simple:

1) Conduct a Monte Carlo analysis of the system (e.g. in Market System Analyzer 

 This drawdown will be mostly 25% higher than your original equity - i.e. in the above system we would have to anticipate a drawdown of 2400 USD instead of 1930 USD.

2) Think of what your maximum accepted drawdown is in percentage and capitalize in accordance to the Monte Carlo drawdown that needs to correspond with this percentage. If you decide that you are able to accept a 50% drawdown on your account, then your capitalization will look like this: 2 x 2400 USD = 4800 USD. If you decide you can accept a maximum drawdown of one third of your account, then your capitalization will look like this: 3 x 2400 USD = 7200 USD.

With a bit of patience and research you can come up with strategies that will be possible to trade under certain circumstances with very small accounts - i.e. 5000-10000 USD.

Once you have a few strategies like this, it is possible to work with small portfolios (2-3 systems). In such case you need to conduct a Monte Carlo analysis on your portfolio as a whole (program MSA is great for that) and capitalize in accordance to the Monte Carlo drawdown of the portfolio.

How to search for strategies for small accounts

So, once more... The good news is that to find a good, quality breakout strategy for small accounts is possible. The bad news is that it will take much more patience and you will always have to compromise slightly.

You have to ask yourself what is the amount you are willing to accept (such amount needs to be reasonable, e.g. 100 USD is a bit extreme, but 300-500 USD seems reasonable) and during the development of the breakout strategy, you will have to implement this as a fixed amount from the very beginning of the whole process, i.e. in search and development of the breakout strategy.

Generally speaking, breakout strategies with small stop-loss are better to find on markets like YM and ES, especially on 15 minutes and 30 minutes timeframes. However, it takes much more patience - to find a strategy for small-stop loss is considerably more difficult (but not impossible). From my experience, sometimes it is worth it to take a tested and proven strategy and to try it on other markets with different stop-loss values. This way I have found, for instance, low values of stop-loss for the BOSS system (but for timeframes higher than 15 minutes). Generally, only one in approximately six of my breakout strategies is usable with small stop-loss. This only confirms the difficulty to search for this kind of strategy - but with an account of around 8000 - 10000 USD, I can imagine to have a portfolio with three such strategies and have a decent base for further growth.

Happy Trading!

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How Much Money Do You Really Need to Start E-Mini Trading?

To read some of the success stories I see being bandied about you should be able to start futures trading with $1,000 and have it transformed within a year to a sum topping six figures. I certainly am not saying that this feat is impossible, but I have never seen it done and have never met another trader who has seen it done. As a trader who is relatively new to the markets, the chances of taking a highly leveraged account that is undercapitalized and expecting anything short of a trading belly flop is delusional thinking.

I have written on this topic before and have since changed my mind on some of the ideas I previously presented. With added volatility, at least added volatility in a scalping sense, it has become difficult to trade with tight stops and widening stops ends up violating every money management rule that has ever been written. With a $3,000 account you could well end up risking 10% of your account on a spike or trading stops that exceed your trading plan's "at risk capital per trade" rules. I recommend risking 3% and no more than 5% on any single trade. In a highly random market it's hard to stay anywhere near those parameters with a small sized account. If you set your stops at the appropriate levels you have too much money at risk, and if you decide to go the "tight stop" route you can count on becoming the "stop-out king."

So, how much money is right to start trading?

I used to feel confident recommending $5000 to start an account and restrict your trading to the $5/tick e-mini contracts, specifically, the NQ and the YM. After some time has passed, I believe a more appropriate starting trading balance should be $10,000. The traders who seem to have the least worries about profit and loss tend to succeed at a higher rate than individuals in small account, and the added cushion in the trading account seems take the pressure off. Trading an undercapitalized account puts tremendous pressure on the trader to win. Pressure is something you don't need in trading.

Further, with a small account many novice traders aren't able to distinguish a day where profit may be hard to come by versus a day when the market is moving nicely and is reasonably predictable. A couple of poorly chosen trades in a tough market can quickly drain a small account and discourage a new trader.

In summary, you have the best chance of succeeding with an account of proper size which is, in my estimation, best pegged at $10,000. This is not to say that a trader with an account half that size can't trade effectively, but rather the added cushion tends to de-pressurize the early stages of trading long enough where some confidence can develop. Extremely small accounts are tough to trade successfully, and should be avoided. Just because the brokerage will let you open an account with $1000 doesn't mean you are on your way to a highly successful trading career, just the opposite, really.

Would you like to start earning 300% every week? So would I... yet you see this type of hype on many sites these days. I don't promise astronomical returns, but 25 years of Wall Street trading experience has helped churn out solid e-mini traders for 5 years. Come see me trade. Real trading doesn't lie.

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