The Ugly Drawdown | Forex Factory

Options

Go to
Permalinks
Print Thread

Similar Threads

Drawdown % vs. Profit 11 replies

What drawdown does everyone use? 18 replies

The lowest drawdown system ever been published? 11 replies

How do I read a statement (drawdown)? 0 replies

Delta&DrawDown? 0 replies

Attachments: The Ugly Drawdown
Exit Attachments

The Ugly Drawdown

  • #1
  • First Post: May 30, 2007 9:31am May 30, 2007 9:31am
I'd like to begin a discussion around drawdown and especially drawdonw in PipBoxer. I want to realistically evaluate the behaviour of PipBoxer in the past. I'm seeking to achieve two main goals through this thread:

 

  1. To show PipBoxer users/potential users that facing drawdown in this system is quite natural and depending on the Risk Management strategy that you take you might lose substantial amount of money before making money. Sometimes you make money first and then lose substantial amount of money depending on when and how you trade PipBoxer.
  2. To improve the behaviour of PipBoxer. This is more geared toward risk managment element of PipBoxer. The discussions will hopefully help us to come up with the best practices in currency diversification and position sizing methods. An indepth look at the PipBoxer can also help me to enhance the strategy.

I would like to insist that a system trader is not a fortuneteller. I am not in the business of predicting the future. I just do my best - based on quantitative and technical analysis - to find the odds of winning. I also incorporate risk management and money management techniques to enhance the behaviour of the system. This is the mentality that has built PipBoxer. If somebody is looking for an instant Pip maker this is not his/her territory. This territory is for those serious traders who want to gradually build up their portfolio, those who are not afraid of the ugly drawdown.

Every single suggestion, comment, or question is welcome here. I hope this also helps everybody else who is focusing on system building to come up with realistic profitable solutions.

  • #2
  • May 30, 2007 9:42am May 30, 2007 9:42am
Investopedi defines drawdown as follows:

"The peak-to-trough decline during a specific record period of an investment or fund. It is usually quoted as the percentage between the peak and the trough."
(Click here for more info)


Wikipedia defines Drawdown as follows:

"Drawdown is the measure of the decline from a historical peak in some variable (e.g., the variable of interest might be the cumulative profit since inception from the purchase of a share of common stock). Somewhat more formally, if X(t) is a random process [http://upload.wikimedia.org/math/4/d...2971ceef86.png], the drawdown at any time, T, is defined as http://upload.wikimedia.org/math/4/e...19165842aa.png
In finance, the use of drawdown as an indicator of risk is particularly popular in the world of Commodity trading advisors with the derivation of three performance measures: the Calmar Ratio, the Sterling Ratio and the Burke Ratio. These measures can be considered as a modification of the Sharpe ratio in the sense that the numerator is always the excess of mean returns relatively to a risk-free rate while the standard deviation of returns in the denominator is replaced by other compilations of drawdown."
(Click here to view the article)
  • #3
  • May 30, 2007 9:52am May 30, 2007 9:52am
Here is something by Rob Booker that looks interesting. Still need to think about it but at first glance I like it.
Attached File(s)
File Type: pdf sol_free.pdf   218 KB | 976 downloads
  • #4
  • Edited 11:10am May 30, 2007 10:01am | Edited 11:10am
Watch the following image. It's taken from the back-test results for GBPUSD (with PipBoxer V2.0):

http://www.pipboxer.com/fximages/PB2-GBPUSD-MIG.gif

The image looks very nice. It seems that you are looking at a curved-fit system that grows contstanctly but think again. If you look at the image closely you can find the areas of drawdown.

An example of drawdown could be found from order 13 to 23. I show you the dates and account balance for each trade (when it gets closed):

13. 2005.01.28 - $19346.00
14. 2005.02.04 - $19336.00
15. 2005.02.09 - $18296.00
16. 2005.02.10 - $18323.00
17. 2005.02.11 - $18313.00
18. 2005.02.16 - $18473.00
19. 2005.02.18 - $18463.00
20. 2005.03.08 - $17013.00
21. 2005.03.10 - $17003.00
22. 2005.03.17 - $16989.00
23. 2005.03.21 - $15324.00

As you can clearly see for a period of almost two month (Jan 28 to March 21) the system goes down and loses a total of over $4000.00 (with 1 lot trade). Now if you had purchased the system at the time and started trading with it what would you had said about it. Two months of consecutive losses.

It took the system 6 more trades and about 2 weeks to get back on track.
24. 2005.03.23 - $18224.00
...
29. 2005.04.01 - $20700.00

Drawdown is real and exists. It takes patience to face it and deal with it. It also needs wise decesions to know how to cope with such situations and reduce the risks.
  • #5
  • May 30, 2007 3:12pm May 30, 2007 3:12pm
Quoting marejp
Here is something by Rob Booker that looks interesting. Still need to think about it but at first glance I like it.
Thanks for sharing this nice eBook. This could be a good approach to evaluate a system.
  • #6
  • May 30, 2007 3:24pm May 30, 2007 3:24pm
This one is more obvious than the other example. Take a look at the following image that is taken from USDJPY back-test (PB V2.0).

http://www.pipboxer.com/fximages/PB2-USDJPY-MIG.gif

A major drawdown begins from trade #137 to #184

137. 2005.12.26 - $50580.01
...
184. 2006.05.01 - $36919.95

As you can see the extent of the drawdown is more than 5 months and the system loses more than $13000.00.

Then the system gets back on track and eventually on trade #219 passes the $50000.00 level.

219. 2006.07.17 - $51237.20

This basically means that the system did generate nothing but panic for about 8 months.

I hope I have managed to explain that drawdown could happen in a profitable system and they can be sometimes severe. I will discuss the ways that we can cope with this problem but let's hold it for now. I hope to hear from you as well.

Thanks,
Al
  • #7
  • May 30, 2007 11:05pm May 30, 2007 11:05pm
Gday Al,

This is an interesting thread you have started! Personally I like to take into consideration both the MaxDD and the NetProfit/MaxDD as I discussed earlier and posted in my spreadsheet. Others will be happy with reduced returns if it means shorter DD periods and less maxDD, whatever helps you sleep at night is best! I don't think there is just one way to analyse it and everyone's tolerance of risk is going to be different.

Take the SOL number posted before, the NetProfit/Max Loss. If you have hundreds of trades and started out with an account balance of $10k and it had grown to $100k but at $12k you experienced an absolute MaxDD of $6k...that's 50% DD on a percentage basis. Say at $80k you experienced an $16k DD, that's 20% DD, however your SOL number would be based on the $16k loss. For me, the scariest moment would have been hitting the 50% DD not the min SOL value. Again, everyone has a different view of things....and that's ok. The one thing we all have in common though is we hate losing money, and it is important to take some measure of that, however that maybe.

The hardest thing in trading a new system is starting out in DD, it can be a killer! You begin to question everything.....Do I stop, do I keep going, if I keep going how long should I keep going for?? No matter how much backtesting you do and demo forward trading there is always that risk of starting out in the negative, the hardest part is having the conviction and belief in a system to keep going. Many a times I have been guilty of giving up too early...it's all part of that learning process I guess.

With PB, like any system, I accept there will be drawdown periods and for now I have no reason to believe that this is not just one of those. The EA's have good management rules and I assigned VAR values which should ensure I do not exceed my max DD comfort levels. Currently I am about 18% DD and feel comfortable with 25-30%.

Anyway, they're just my ramblings and thought, best of trading to everyone for the new month!
  • #8
  • May 31, 2007 1:54am May 31, 2007 1:54am
fresian,

Thanks very much for your input. I agree with you. Even when you trade with an automatic system like PipBoxer the psychology of trade plays a big role. It's more geared toward money management and risk management though.

I hope to hear from more people. This discussion can help us improve our trading habits, our expectations, and much more.

Good Luck,
Al
  • #9
  • May 31, 2007 2:32am May 31, 2007 2:32am
I had this exact problem with my system.

Initial drawdown varying between 10% to 20 % on initial account equity for the first six months but the backtesting expectancy was positive the risk control was tight and now, 3.5 years later with the same system I am up 1600% (cumulative daily %). The first six months was tough but it's just part of trading life. You must be disciplined, as we all know.

It is a fully automated API trading system
  • #10
  • May 31, 2007 2:50am May 31, 2007 2:50am
Quoting Jason
I had this exact problem with my system.

Initial drawdown varying between 10% to 20 % on initial account equity for the first six months but the backtesting expectancy was positive the risk control was tight and now, 3.5 years later with the same system I am up 1600% (cumulative daily %). The first six months was tough but it's just part of trading life. You must be disciplined, as we all know.

It is a fully automated API trading system
Thanks very much for your input.
  • #11
  • May 31, 2007 5:40am May 31, 2007 5:40am
My method of reducing the equity damage with extended periods of drawdown (in the order of six months - this does happen) is to automatically reduce the risk per trade to 50% of normal (say 1% per trade instead of 2%) when account equity falls below the 55 SMA of the equity curve. The risk is then increased to normal when actual equity rises above the 55 SMA.

This works exceptionally well for me but could be adjusted to suit the individuals goals, risk tolerance, and trading system.

Just another idea for the armoury if you don't like it.
  • #12
  • May 31, 2007 8:39am May 31, 2007 8:39am
Quoting Jason
My method of reducing the equity damage with extended periods of drawdown (in the order of six months - this does happen) is to automatically reduce the risk per trade to 50% of normal (say 1% per trade instead of 2%) when account equity falls below the 55 SMA of the equity curve. The risk is then increased to normal when actual equity rises above the 55 SMA.

This works exceptionally well for me but could be adjusted to suit the individuals goals, risk tolerance, and trading system.

Just another idea for the armoury if you don't like it.

Thanks Jason,

Do you use a special software package to calculate the 55 SMA of the equity curve?

Thanks,
Al
  • #13
  • May 31, 2007 12:49pm May 31, 2007 12:49pm
The 55 period SMA of equity, when one period is one trade, can be calculated easily within the automated system and then the appropriate risk applied.

If you keep a record of equity curve per trade (or cumulative daily % which I think is preferable as it removes the $$ signs if you are doing things manually), as i guess most traders do, in MS excel you can apply a MA in the chart feature and visually inspect it or quite easily calculate the MA value and compare to current equity manually or via a formula and adjust trade risk accordingly.

You don't need any specific software to do it but as things get more automated you can build it into your system.
  • #14
  • May 31, 2007 1:13pm May 31, 2007 1:13pm
I believe in keeping things simple.

No more than 20% drawdown for me.

For example if I start out with $2,000 and grow it initially to $2,500. Then I have a series of bad trades which causes the balance to go down 20% back to $2,000. This is where I say get out of these trades, evaluate, test, analyze before you enter again.

"Brake even is better than broke" Mark Olivero

There has to be a fixed point at which you will not allow your account to go below. Why? Because in Forex it is easier to lose money than to make money.

Drawdown is certainly a part of trading, but there is sometimes too much discussion about drawdown instead of a lot of discussion on how to sharpen your discernment skills to make good trades, stops if any, and good exits. I deliberately trade in a style that will not allow me to go into more than 5% drawdown in about 90% of the pips earned. 20% drawdown can happen but not often. I hate drawdown more than I hate missing a good trade. (or was it?)
  • #15
  • May 31, 2007 3:01pm May 31, 2007 3:01pm
Quoting Jason
The 55 period SMA of equity, when one period is one trade, can be calculated easily within the automated system and then the appropriate risk applied.

If you keep a record of equity curve per trade (or cumulative daily % which I think is preferable as it removes the $$ signs if you are doing things manually), as i guess most traders do, in MS excel you can apply a MA in the chart feature and visually inspect it or quite easily calculate the MA value and compare to current equity manually or via a formula and adjust trade risk accordingly.

You don't need any specific software to do it but as things get more automated you can build it into your system.
Thanks very much for providing me with more info. I beleive you have selected a good approach to managing your portfolio. This can lead to a system for variable position sizing.
  • #16
  • May 31, 2007 3:04pm May 31, 2007 3:04pm
Quoting KudzuFX
I believe in keeping things simple.

No more than 20% drawdown for me.

For example if I start out with $2,000 and grow it initially to $2,500. Then I have a series of bad trades which causes the balance to go down 20% back to $2,000. This is where I say get out of these trades, evaluate, test, analyze before you enter again.

"Brake even is better than broke" Mark Olivero

There has to be a fixed point at which you will not allow your account to go below. Why? Because in Forex it is easier to lose money than to make money.

Drawdown is certainly a part of trading, but there is sometimes too much discussion about drawdown instead of a lot of discussion on how to sharpen your discernment skills to make good trades, stops if any, and good exits. I deliberately trade in a style that will not allow me to go into more than 5% drawdown in about 90% of the pips earned. 20% drawdown can happen but not often. I hate drawdown more than I hate missing a good trade. (or was it?)
Kudzu,

Thanks for your input. I believe many novice traders or those who expect too much from forex do not consider the fact that drawdown exists and should be handled properly. A good knowledge of drawdown and handling it can help us to develop custom-built risk managment techniques for our trades. It's better to cope with it rather than ignore it.

You have certainly resolved the issue for yourself. This is great.

Thanks,
Al
  • #17
  • May 31, 2007 3:47pm May 31, 2007 3:47pm
Thanks Aparsai,

I am currently forward testing a strategy of mine, and am in a period of drawdown myself. Although I intellectually realise that it sometimes takes weeks (in the backtest) to recoup a few losses in a row, it has been slightly unnerving for me when the weeks are real weeks, not just dates on a screen.

It's good to know that even the big boys like you run into issues like this from time to time

Sorry for being totally off topic (not about PipBoxer), but it's really nice to know that others have had the same issue if the timing of the start of the forward test is off.

Seavo
  • #18
  • May 31, 2007 3:51pm May 31, 2007 3:51pm
Quoting Seavo
Thanks Aparsai,

I am currently forward testing a strategy of mine, and am in a period of drawdown myself. Although I intellectually realise that it sometimes takes weeks (in the backtest) to recoup a few losses in a row, it has been slightly unnerving for me when the weeks are real weeks, not just dates on a screen.

It's good to know that even the big boys like you run into issues like this from time to time

Sorry for being totally off topic (not about PipBoxer), but it's really nice to know that others have had the same issue if the timing of the start of the forward test is off.

Seavo
Hi Seavo,

Thanks for your post. Drawdown is a fact that is hard to digest. We should accept it and find the best ways to deal with it upfront. If you have a proper risk management in place and know your system well then you won't be afraid of drawdown.

BTW, I don't mind if I hear about anything related to drawdown and risk management on this thread.

Good Luck,
Al
  • #19
  • Jun 1, 2007 9:21am Jun 1, 2007 9:21am
One solution to deal with the drawdown problem which I personally found very effective is to diversify your trades between several pairs. Let me give you an example.

If you refer to post#4 you can clearly see that GBPUSD showed over $4000 drawdown or to be specific, if you had traded 1 standard lot on GBPUSD from Jan 28, 2005 to March 21, 2005 you would have lost $4022.00.

Now let's spread the risk among 5 pairs (i.e. GBPUSD, USDJPY, GBPJPY, AUDUSD, and EURGBP). To get similar results we trade 0.2 lots per pairs. Here are the results:

GBPUSD loses $804.40
USDJPY loses $71.35
GBPJPY loses $2271.76
AUDUSD loses $216.80
EURGBP gains $437.99

As you can easily see the loss for GBPUSD drops to $804.40 and the total loss drops to $2926.32.

Although the overall performance was week but we managed to drop the loss by over 25% which is great. At the end of the day what matters is to lose less and of course gain more. With diversification we managed to approach this goal a little bit.
  • #20
  • Jun 1, 2007 9:28am Jun 1, 2007 9:28am
We repeat the same experiment for our other example. Reffering to post#6 you'll see that from Dec 26, 2005 to May 1, 2006 USDJPY loses $13660.06 if you trade 1 standard lot.

Now we trade 5 pairs and 0.2 standard lot on each. Look at the results.

USDJPY loses $2732.00
GBPUSD gains $1217.00
GBPJPY gains $2564.20
AUDUSD gains $761.00
EURGBP gains $369.84

We gain a total of $2180.63. With diversification we managed to stop losing over $13000 and gaining over $2000. This potentiall means that a simple approach saved us over $15000.00

Diversification matters, doesn't it?

I'll continue this discussion but I stop right now to hear from you.

Good Luck,
Al
0 traders viewing now