Drawdown Calculation

Discussion in 'Trading' started by traderguy02, Oct 27, 2005.

  1. Would someone be willing to give me a good definition of drawdown and how it is calculated. I know this much: drawdown is calculated as the difference between the greatest peak and greatest valley divided by the total equity.

    for example: 15000 - 12000 would give you

    3000/15000=20 %

    Where I am lost is on the amount of capital invested and how it effects the drawdown calculation...

    for example...lets say I started with a $10000 account it moved up to 15000 and then retraced to 12000 before moving up again...well lets assume the account was fully invested with 10k...so at 15000 your trading system made 50% and lost 20% when it retraced to 12000

    Now assume you only risked 50% of your account on a different system..$5000..and this system also went to 15000...now this system makes 100% and apparently also loses 60% of the profit on drawdown...but still remained profitable by staying above 10000 with a 20% draw...

    So the main question is: Is the drawdown on the second system the same as the first system b/c you did not risk as much money?...or should there be a different figure for the drawdown percentage on the second system

    I am confused as to how you factor in your risk capital when determining drawdown...because if you had used system #2 in trading with full investment of 10k...then you would have gone up to 20k and retraced to 14k thus giving a drawdown of 30%??

    Can anybody explain this better? thanks
  2. Your pointing out the difference between open equity drawdowns and principle drawdowns. Usually, because when trading you cannot predict when either may occur, authorities look at total drawdown which is for the drawdown of an account from its highest point in the past to its lowest point in the present.

    The drawdown formula for recovery from a drawdown:

    100 / (100-drawdown)= X factor

    100 / (100-40) = 100/60 = 1.66 factor = 66% increase to recover from drawdown

    100/ (100-10) = 100/90 = 1.11.. factor = 11% increase to recover from drawdown.
  3. ok psytrade...thanks for the clarification
  4. Just to clarify, drawdowns in the past, as described " the system had a 40% drawdown" means that at some point in the past, there was an equity drop of 40% from the peak high. Usually most professional CTAs and funds have no more than 50% drawdowns, though most prefer to have less drawdowns, around 25% or so.
  5. I think I am also wondering at what point do you throw out a system b/c of its drawdown

    If a system works with proper capital management it would seem feesable...however if you decided to crank up the juice and risk much more capital it could be disasterous.

    How do you use drawdown to determine whether a system is worth holding onto...which drawdown scenario do you use...principle or equity?
  6. So how are returns calculated as you add or withdraw funds? Let's say you start off with $10k and add $2k/ month and after 12 months you have $50k.
  7. no idea when you start adding money at various times. but this will work for end to end:

    total Net - total added capital = Profit

    Profit / added capital = % return

    compute for whichever timeframe you desire i guess.
  8. Yeah, I guess that is a stupid question. One could just base their returns on whatever capital was traded for whatever length of time. It would not be exact however because things like interest and small fees and credits from other capital would be a pain in the ass to calculate.
  9. Always use equity high to calculate drawdown. Using initial principal is meaningless.

  10. Current Equity Level - Beginning Capital - Capital Added during 12 months = Profit Earned for Year

    Next, Calculate Average Capital Employed During the Year by weighting it with the months. Example: Started with 10k, after 5 months add another 5 k. By end of year, equity is 22k.

    So, profit = 7k.
    Weighted capital is (5/12*10k)+(7/12*15k)=12.9k
    Return for the year = 7/12.9 = 54.2%.
    #10     Oct 28, 2005