System drawdown

CPTrader · Jun 19, 2008

Quote from hausse:

I can't say anything about day trading systems. I do long-term trend following, a different game. If you are day trading you may need different answers. In the past I went through drawdowns of >40% and kept following the signals but it was gut wrenching and the temptation to second-guess the signals was very much present, nah extreme. Back then I was willing to take bigger risks to get high returns. So it is when building up something.

Markets can move such that the profitability of any trend following system I can imagine suffers. This usually means rugged or absent trendiness and that in seemingly unrelated markets at the same time.

Once I have dropped a system because it's equity curve had a very strong rise (equity increased 7x from previous drawdown low) and initial risks for new trades became so high that I considered it unreasonable and I didn't want to give back too much of the equity build up. The system then went into a new max drawdown and it took it years to recover. But recover it did. One wouldn't do that strictly by the book, however.

Like I said earlier, I don't think one can tell in advance if a system stays profitable or not. Whether you want to continue to trade a system in a drawdown is a very individual decision and depends on your confidence in the system, financial and general situation, risk willingness. Following trends as a principle I believe is a valid approach and as such is something I am betting money on in spite of increased risks due to higher volatility and deeper retracements and there is nothing that I know of suggesting that there is a limit to adverse conditions one may encounter. Implementing several systems and trading more markets tends to smooth the equity curve but is no guarantee. There aren't any, it is speculation after all.

I would continue to trade if the funds allocated to a system are down 50%. That is because I consider trend following a valid principle and have made up my mind in advance that I can live with that kind of variance. I wouldn't start trading a system when the drawdown in testing is very high. When I encounter it in real trading I'd keep going until either the allocated funds are depleted or until the next profit wave; then I'd reconsider. Wouldn't bet the farm, however. Just what I allocated to it.
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Hausse, thanks for sharing your insights. How do you calculate DD, on and EOD basis or EOM basis. I notice most CTAs, hedgefunds calculate DDs using month-end numbers. Is this what you do - or do you calculate it using EOD numbers?

hausse · Jun 19, 2008

Quote from CPTrader:

Hausse, thanks for sharing your insights. How do you calculate DD, on and EOD basis or EOM basis. I notice most CTAs, hedgefunds calculate DDs using month-end numbers. Is this what you do - or do you calculate it using EOD numbers?
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I use EOD numbers.

CPTrader · Jun 19, 2008

Thank you, hausse

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System drawdown

CPTrader

hausse

CPTrader