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Chuck's comments about how TS calculates drawdown are accurate. However,
code needed to compute the Mark-to-Market drawdown was published in TS
Express, providing the missing ingredient. Even better, we published code
to perform Monte Carlo simulation.
Your preference for percentage accuracy would apply only to a narrow range
of systems. Some systems have low percentage of accuracy and are very
profitable. Some systems with high percentage of accuracy can actually lose
money.
At 02:06 PM 1/5/99 -0800, you wrote:
>
>Chuck LeBeau's System Traders Club
>Bulletin Vol.1 Number 18January 5, 1999
>
>
>Happy New Year from all of us at the System Traders Club. We hope you
>had a good holiday.
>
>
>Drawdown is a topic that is seldom discussed in depth because everyone
>assumes that its meaning is obvious and that they understand how it
>should be used in evaluating or capitalizing a trading system. Of all
>the statistics used in evaluating a trading system's performance I have
>found that Drawdown, however it might be defined, is a very unreliable
>statistic at best.
>
>First lets look at how Drawdown is commonly calculated and expressed.
>This varies widely throughout the industry and even varies within Omega
>products. For example in TradeStation and SuperCharts, MaxDrawdown is
>calculated from a position's entry point and not from a position's peak.
> If we start a trade, which at some point achieves an open profit of
>$1,000, and then later close it out at a loss of $500, TradeStation and
>SuperCharts will record a Drawdown of only $500. However, Omega's
>Portfolio Maximizer would look at the same data and record a Drawdown of
>$1,500 which is more in line with general industry practice and is the
>method by which the CFTC and NFA require Commodity Trading Advisors and
>Pool Operators to calculate Drawdown.
>
>At first glance one might assume that the CFTC/NFA calculation is
>fairer, or at least more conservative, but that isn't necessarily the
>case because the regulators require that drawdown be expressed in
>percentage numbers rather than in dollars. Ask a CTA for their maximum
>drawdown and you will receive an answer like "35%" not XXX dollars.
>This makes the size of the drawdown as much dependent on the size of the
>account at its peak as it is on the size of the decline in equity. A
>$10,000 drawdown from an equity peak of $100,000 is 10% and the same
>$10,000 drawdown from an equity peak of $200,000 would be only 5%.
>Using this formula it would also mean that a trader who never had a loss
>would still report a drawdown because the giveback of open profits is
>included as "Drawdown". Omega's Portfolio Maximizer uses this method to
>calculate Drawdown and it differs substantially from the way that
>TradeStation and SuperCharts calculate Drawdown.
>
>Even if we assume that we understand which specific Drawdown calculation
>we are looking at and know how it was calculated, the meaning and
>application of this statistic are still very suspect. Let's use the
>trade by trade report of three systems as an example.
>
>System "A" begins trading and has the following closed out trades (we
>only need a very small sample to illustrate our point):
>
>Loss of $500
>Loss of $250
>Gain of $2,000
>Loss of $500
>Gain of $2,500
>Gain of $1,000
>
>Using the TradeStation formula this system would have a MaxDrawdown of
>$750. Keep in mind that if the first trade started out as a $1500 open
>profit at some point before it was closed out at a $500 loss, the
>Portfolio Maximizer formula would have recorded the drawdown on this
>trade as $2,000 not $500. However, lets keep our examples as simple as
>possible and record the MaxDrawdown for system "A" as $750 (the results
>of the first two losses, $500 plus $250) as it would show in
>TradeStation.
>
>Now lets look at the trades for system "B":
>
>Loss of $500
>Gain of $2,000
>Gain of $2,500
>Loss of $500
>Gain of $1,000
>Loss of $250
>
>Using the TradeStation formula this system would have a MaxDrawdown of
>$500.
>
>As our final example, lets look at system "C":
>
>Gain of $1,000
>Gain of $2,500
>Gain of $2,000
>Loss of $500
>Loss of $500
>Loss of $250
>
>Using the TradeStation formula this system would have a MaxDrawdown of
>$1250.
>
>All three systems made $4,250 and had 50% winning trades. The size of
>the average winners and losers was identical, as was the Profit Factor
>(Gross Profits of $5500 divided by Gross Losses of $1250). However, the
>MaxDrawdown, Account Size Required and Return on Account would all vary
>substantially.
>
>Which system is best? Which system has the best risk to reward ratio?
>How should each system be capitalized? Which system is most likely to
>have the smallest drawdown in the future? In our opinion A, B, and C
>are all the same system and there is no way to differentiate between
>them.
>
>Our sample of trades is purposely small but it wouldn't matter much if
>it were 300 trades instead of only six. In our opinion the sequence of
>trades in the future will be random and the only valid way to estimate
>possible drawdowns would be to scramble a large sample of trades and
>redistribute them randomly. The result might then be expressed as
>something like this: "Based on a starting capital of $100,000 there is
>a 28% probability of a drawdown of 50% given 10,000 trials." This
>drawdown study would require a program that would accept the trade by
>trade output and then perform a "Monte Carlo" simulation that would
>redistribute the trades in a different sequence over many trials. Even
>then our real time experience with drawdowns will be impossible to
>quantify with any accuracy. The best we can do is to find a range of
>probabilities and hope that our actual experience falls somewhere within
>that range.
>
>We know of at least one program that was developed to do this type of
>drawdown simulation. It is not currently offered for sale but if we can
>persuade the developer to offer it to our members at a reasonable price
>we will make it available. There may be other programs that can do this
>simulation as part of a bigger package but they are generally quite a
>bit more expensive than the specific software we have in mind.
>
>When building our trading systems we assume that our members would
>prefer systems that have relatively small historical drawdowns. However
>we believe that the percentage of winning trades and the size of the
>winners vs. losers are a much better indication of what to expect in the
>future than the historical Drawdown statistics viewed out of context.
>This is one of the reasons you will find that our systems generally
>emphasize a high winning percentage. In our experience a high winning
>percentage is the factor that most helps us to control drawdowns.
>
>To summarize, we can not afford to ignore data related to Drawdowns, but
>we must be very careful how much we rely on this information. As we
>have attempted to illustrate in this Bulletin, historical Drawdown data
>tells us very little about what to expect in the future. We suggest
>that when you look at this data you consider it for the limited value it
>might have; but don't ever count on it. Of all the performance data we
>might review, Drawdown and the data calculated from it (Account Size and
>Return on Account) appear to be the least reliable.
>
>
>
>**************************************************
>
>
>Webmasters Report
>
>We are continuing to improve and upgrade our website in order to make it
>better and easier to use. There are several new projects underway that
>we hope to have completed in the near future. One is a self moderating
>classifieds section. This will allow you to post your own classified
>advertising and will require no intervention by us, and will be
>incorporated into the Forum as a topic area. There are other changes
>coming to the forum as well and as soon as they are up and running we
>will make a general announcement and let you know about it.
>
>We have streamlined our join process, so that all a new visitor to the
>site needs to do is enter their email address into a form and they are
>registered as a member. If you know of anyone who would benefit from
>the website please feel free to introduce them to us by forwarding them
>this bulletin or sending they our url.
>
>We have added complete System Results Reports to all systems that trade
>Long and Short. Previously we only had the combined results reporting on
>the systems pages. Also you will find a link on each system page to the
>complete Trade by Trade Report for the System.
>
>As always please feel free to email me with comments, suggestions, or
>questions regarding the website
>
>David Elden
>webmaster@xxxxxxxxxxxxxx
>
>
>***************************************************
>
>
>
>Chuck LeBeau
>
>
>mailto:chuck@xxxxxxxxxxxxxx
>http://traderclub.com
>
>
>
>
>
William Brower
Publisher of TS Express
Email: 1000mileman@xxxxxxxxxxxxxx
Web: http://www.insideedgesystems.com
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