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Glen, if you had a methodolgy that resulted in a 60 % win factor that
produced $12,000 worth of net profits but had a draw down of $19,000 and
you had a trading account of $20,000, would you want to trade this
methodolgy and risk $19,000 (or most of your account) to make $12000?
I interpret draw down as the 'risk' measure in "risk and reward". Also, if
your system tests in test data showed a 60% win factor, that is not
indicative that the same percentage will apply to out of test data or the
real world.
I do think you have started a very interesting thread, and I look forward
to reading other opinions of this question.
Al Taglavore
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> From: Glen Wallace <gcwallace@xxxxxxxx>
> To: MetaStock listserver <metastock@xxxxxxxxxxxxx>
> Subject: Is drawdown meaningless?
> Date: Monday, August 30, 1999 5:14 PM
>
> I first came across this idea several months ago, but at first I did not
> fully understand. The fog is now lifting, and I want to toss this out,
> first, to get other people's thoughts and reactions, and second, to
collect
> my own thoughts.
>
> Simply stated, drawdown is the largest equity dip caused by a sequence of
> losing trades, and many use it to assess whether a system is tradeable.
>
> Assuming there is no mathematical dependency between wins and losses (ie.
a
> win does not beget a win, or a win does not beget a loss) in a system,
the
> fact that your system test just happened to find, say, five consecutive
> losses is irrelevant. Consider a series of coin tosses. Even though there
is
> a 50% probability of heads, a sequence of five consecutive tails is
fairly
> common, but shouldn't influence a person to not bet on heads. In fact, a
> sequence of 10 consecutive tails is quite possible, yet the probability
of
> heads on the next toss is still 50%. An analysis of this 10-sequence
> drawdown might mislead an investor into believing the coin-toss trading
> system is too risky. In contrast, let's say that the series of coin
tosses
> yielded no consecutive losses, thereby giving the investor the false
> impression of a small risk. In either case, the calculated drawdown is
> meaningless.
>
> If there is no dependency between wins and losses, can we expect past
> drawdowns to repeat? Can we expect future drawdowns to be bound by past
> extremes? No; there is no limit to the possible number of consecutive
losing
> trades. Drawdown is not meaningful, other than to give some false peace
of
> mind.
>
> Since there is no limit to the number of possible consecutive losses and
it
> is uncontrollable, the better yardstick is the size of the largest losing
> trade. To an extent, this can be controlled. And with proper money
> management techniques, you can structure your trade sizes so as to
survive
> the inevitable string of losses.
>
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