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Article is from his new site at www.powertradesignals.com not
powerdaytrade. Powerdaytrade was the old site.
> Article from www.powertradesignals.com
> Drawdowns - They Can Always Get Bigger
> May 20, 2001
>
> I will admit, as long as I have been trading, as many drawdowns as I have
> gone through, and some totally devastating some of my accounts before the
> days I focused on money management, they never, ever get any easier. In
> fact, logically, they get harder to go through. Why, because I have been
> trading for so long, have done so much research, probably have just as
much
> knowledge on trading as 99% of anyone out there and still go through them.
> More than 15 years of breathing and living the markets and trading, you
> would think that someone would have this drawdown thing licked. That
> logically makes them even more frustrating. Everyone expects a beginner to
> go through drawdowns, but a World Cup champion trader???? But, here I sit,
> going through a really hard drawdown again. Fact of life is that for as
long
> as I trade, there will always be drawdowns. So it is a good thing to
> understand everything you can about them in order to properly deal with
> them.
>
> First, it is important to know and understand that historical drawdowns
are
> independent events. One drawdown one year is not linked to another
drawdown
> during a different year. In other words, one drawdown NEVER sets the
> standard for future drawdowns. This is probably one of the biggest
mistakes
> almost all traders make when evaluating drawdowns. "Well, the largest was
> $10k so if it goes above a $10k, then the system is broke". WRONG! WRONG!
> WRONG! That is like saying that if the historical drawdown was $10k and
the
> system is approaching another $10k drawdown, that the system actually
knows
> that the previous largest drawdown was $10k and therefore better start to
> turn around. Or better yet, some traders actually think that the system
> KNOWS that it is even in a $10k drawdown. Since each trade is independent
> from another, there is NO WAY a system can know what size of drawdown it
is
> in and
> therefore begin to turn around. So if all this is true, then my question
is
> WHY DO WE EXPECT SYSTEMS TO ABIDE BY SUCH FOOLISHNESS? Well, the short
> answer is because many times, we as traders do not want to face reality.
We
> want to think that there is actually a limit to how big a drawdown can
get.
> Reality is that if everything I said about trades and drawdowns is true,
> there is no limit. If that is the case, the question is how can we use
> historical results regarding drawdowns to help prepare us to properly deal
> with them?
>
> Here is how I used the historical drawdown results to help me plan for my
> World Cup 2001 contest trades. First, I know what the largest drawdown was
> on a historical basis. $10k. Next, I also know what the average drawdown
was
> each and every month; just over $4,500. In fact, if you look at last years
> statistics, I think there were only 3 months total that did not have a
> $4,500 drawdown at some point during the month. So my average was almost
$5k
> and my largest only twice that average. Probably not realistic to plan
for.
> So, I planned for a $15k largest.
>
> There are four main aspects to planning. The first is how much money and
how
> many contracts am I going to start with. Regardless of how much money, I
> always say start with one, if not less. Second, I plan for when I will
> increase contracts. Third, I plan for when I will decrease contracts.
> Finally, I plan for when I will stop trading the method. All of this is
> planned before I ever take the first trade. My plan with PowerTrade in my
> contest was to use a variant of my Fixed Ratio method similar to using a
> $4,500 delta on the increase. Second, I would not decrease unless the
method
> went into a $10k drawdown. Third, I would drop contracts twice as fast as
I
> increased them once the drawdown increased above $10k. Finally, (and this
is
> the one you need to pay attention to for the purpose of this article) I
> would quit trading the method if similar market action during good
> performance periods in the past produced a prolonged and sustained
drawdown
> greater than my max that I was planning for. Right now, I am going through
a
> drawdown of just above that $15k I had planned for. My plan was to look at
> the market and see if the market action during the drawdown was similar to
> market action during "good" periods with the system or was market action
> similar to that during past drawdowns. The answer is the latter, which is
> why I decided to continue to take the trades. In other words, if a system
is
> properly applied to the market, large drawdowns should occur in similar
type
> cycles of the market. Likewise, the a system is properly applied, high
> performance periods should happen in similar market conditions. This is
what
> I look for. If my current $15k drawdown was occurring during market
> conditions that were similar to market conditions in the past that
produced
> profits, then my system is suspect.
>
> To give you an example with PowerTrade S&P LT, during average market
action,
> I suffered, on a regular basis, $5,000 drawdowns. During market action
where
> trends prevailed, the average drawdown would be smaller. During market
> action where sideways movement was dominant, larger drawdowns would ensue.
> Hence the size of the drawdown is inextricably related to the type of
market
> action going on. In the case of PowerTrade, sideways action equals larger
> drawdowns. As a result, it is impossible to accurately forecast the
maximum
> size of the drawdown in terms of dollars unless you have a crystal ball to
> tell you how long a market is going to move in a sideways pattern.
>
> If the size of a drawdown can not be accurately predicted, how do you
> prepare for them in trading? By dropping to the absolute minimum risk
until
> the market gets back to normal. If that means trading an emini, so be it.
> But the wrong thing to do is to stop trading it when you have the ability
to
> continue when you know that sideways market action drawdowns are normal
for
> the method. It is when the market is moving with a discernable trend for a
> month or two and PowerTrade S&P LT is going into a drawdown that you know
> the method is probably
> flawed.
>
> Let me tell you why it is wrong for you to stop trading during these kind
of
> circumstances. Plain and simple, because there is NOT ONE SINGLE METHOD,
NOT
> ONE SINGLE SYSTEM that is not governed by the principles I just
> outlined with regard to drawdowns. So you stop trading this method, where
> are you going to go to escape these principles regarding drawdowns?
NOWHERE!
> You will run into the same thing, over and over and over and then you die.
> The only thing you can do is pick out the method you feel gives you the
best
> reward potential over the long haul for the risk, and then make and
> implement your plan. This is why I chose PowerTrade for my contest, it
> offers the greatest potential for the risk involved. Still does and until
> the method shows that it is flawed by not doing well when the market is
> moving, I will stick with it.
>
> I will let you in on a couple of other things before I end this article to
> let you know how I know when a method is not flawed. (when I say flawed I
> mean probably unexpected to produce a positive expectation over the long
> run. A method is not flawed simply because it goes through drawdowns, or
> doesn't catch all the moves or doesn't make money month end without
missing,
> as many traders define "flawed" as). If I am trading daily bars and the
> daily bars are in a pretty good sideways action and producing a drawdown
> with PowerTrade, I will look at a shorter time frame in the same market.
> Normally, there are some trends that occur within the average volatility
of
> a market. If the shorter time frames are showing some intra-day trending
> movements, PowerTrade should, in theory, be posting some winning trades.
> With many markets, intra-day trading is not realistic due to slippage,
costs
> and lack of profit potential with the intra-day moves, but you can still
> look at where the method would have entered and exited and make a
> determination. With the PowerTrade S&P LT, I began looking at the S&P XT
> which trades on 5 minute bars, far shorter than the LT. While the LT was
in
> a larger drawdown, the XT was doing quite well. That isn't always the case
> as there are times when you have to go to an even shorter time frame to
> compare or pull some intra-day trends, but you get the point.
>
> Finally, I want to touch on what I seem to ALWAYS come back to regardless
of
> what subject I am talking about in trading. Money management. You will
> notice that I listed four main aspects to planning for drawdowns. Three of
> them had to do with proper money management. There is an entire article
> dedicated to this one principle to dealing with drawdowns. When a method
is
> producing profits, take advantage of it with proper money management and
> plan to that point of no return. The point of no return is, in theory, a
> point that your account reaches that, regardless of what happens from then
> on, you can not end the account in negative territory. In other words, you
> apply proper money management so that you can continue trading the method
> even if it goes through drawdowns unimaginable. For example, I started
with
> $15,000 in the World Cup contest this year. During good performance
periods,
> I took the account up to over $107,000 and reached a point of no return.
At
> that time, I had increased to trading 6 contracts. A drawdown ensued and I
> began dropping contracts according to my PRE-TRADING plan. Eventually, the
> drawdown reached a point to where I was once again trading only a single
> contract at $55,000. This means that I could continue to suffer an
> additional drawdown of $40,000 and still be making money in this account.
>
> In conclusion, drawdowns are not as predictable as most traders believe.
> Further, the mere size of a drawdown does not indicate whether a system is
> "broke" or not. The next time you plan trading a method, or the next time
> you begin to suffer a drawdown larger than you expected, make sure your
> expectations were based on the proper data and plan them out with proper
> money management.
>
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