[RT] Re: Simple Trading System [also sold commercially]

[Dennis Holverstott <dennis@xxxxxxxxxx>]

Phil Lane wrote:
> The bigger issue is this thing of backtesting on a contract with a huge
> historical range like the SP with a fixed size. As usual nobody seems to
> understand my meaning (of course I didn't get it either for a number of
> years) - so I appologize in advance, this could get lengthy!

Phil is right!!!! 

This could get lengthy and I doubt everyone will agree but I'll get
things rolling with a simple test. It gets back to the money management
thing. Assuming you have a profitable system, you want to know how much
you can risk on each trade and not go broke. The historical maximum
drawdown of the system is a useful tool but you have to compare that
drawdown to how much you would have been risking at the time. One way to
do that is to change your bet size in the backtest so you are risking an
equal dollar amount on each trade.

Let's take the simplest system - buy the Dow Industrial Average in 1928
and hold until now. What was the maximum drawdown from an equity peak
that you had to suffer through?

If you look at points or dollars, which is what a historical backtest on
one contract does, that's easy. We just had it. The high on 1/14/2000
was 11750.3. The low on 2/25/2000 was 9836.1. The drawdown was 1914.2
points or 16.3%. 

So, over our 70+ year backtest, we never had a drawdown bigger than 2000
points and that would be a good number to use for bet sizing... right?

WRONG!!!!!!!!

Lets look at 1929. The high on 9/3/1929 was 386.1. The low on 7/8/1932
was 40.6. That's a drawdown of 345.5 points, barely a good one day move
in today's market. It would show up as an insignificant blip on our 70
year, 1 contract backtest. But those 345.5 points represented an 89.5%
drawdown from the high.

So we need to adjust those numbers. In today's market, an 89.5% drawdown
would be over 10500 points. THAT'S your real risk!!!!!

To use a more recent example, let's try 1987. The high on 8/25/1987 was
2746.7 and the low on 10/20/1987 was 1616.2. That's a drawdown of 1130.5
points or a little over half our recent drawdown. But it's a drawdown of
41.2%. Putting that in terms of today's market, that would be over 4800
Dow points.

Enough from me, I'm done. Take it away, Phil.

-- 
  Dennis