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I agree with your comments on drawdown if there is no mathematical
dependency between results. But I don't think this premise is generally
valid for most. A method generally takes advantage of a certain type or
mode of market. When "in the groove" your win probability may be 70%, when
out maybe 30%, but with an overall expectation of say 50%. If there is a
prolonged phase of the "30%" market - which will happen sooner or later -
you will have more losses than you might expect and a correspondingly higher
drawdown.
regards
Peter
> -----Original Message-----
> From: Glen Wallace [SMTP:gcwallace@xxxxxxxx]
> Sent: Tuesday, August 31, 1999 10:14 AM
> To: MetaStock listserver
> Subject: Is drawdown meaningless?
>
> 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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