Traders' Roundtable

Hi traders and researchers,

Which drawdown figure do you prefer to use when evaluating a trading system: closed-trade or open-trade drawdown? For systems trading multiple markets I prefer open-trade DD calculated every day on the close. I found that closed-trade DD often distorts the reality. For example, if you have several open positions and close one of them at a big loss, your closed-trade DD drops even though your equity may have actually risen since the liquidation of the previous position due to big profits on other open positions. Also, I remember doing a simulation in Excel which showed that for a particular equity curve I was analysing the max open-trade DD was lower that max closed-trade DD (due to the effect I described above), although all books and sites that I read said it should be the other way round.

Tomasz

In some cases it is completely a matter of individual preference. Whatever feels good, do that, and feel good. Van Tharp's $100 report discusses four different ways to calculate drawdown, each one having its own loyal following.

In other cases, such as managing Other People's Money, there is no choice. The reporting format is dictated by external forces. Managed Accounts Review and IASG look at open trade equity (monthly data) when determining drawdown, regardless of your opinion on the suitability or wisdom of this choice.

If you have no choice: live with it. If you do have a choice, select whichever method suits you best and be grateful for the freedom. Many are not so unconstrained.

I look at two drawdowns:

Open Equity Drawdown - Calculated daily on the basis of the close of all positions.

Closed Trade Drawdown (modified to include locked-in profits) - This uses the greater of the actual closed trade equity or closed trade equity plus locked-in profits each day. Locked-in profits are based on the stop level set before the close each day for each market for which there are positions.

- Forum Mgmnt

To me closed drawdowns are like the backtesting regime. They are the history that got the account this far. They represent the huge subject of how to measure systems, that I have yet to see a failsafe answer for.

Emotionally live drawdowns are the worry, fear of that ultimate draw down that takes all the money you let it get, until you decide your out.
Actual trading sees drawdown as live. Quite a bit of time is spent in drawdown ( the time spent while the account is less than its highest value) even though the trading is profitable it quite often takes time to get back past the losing runs. I keep separate drawdowns for each instrument (eg,Yen) as a result of the amount of account allocation it receives, as well as the account total. I like keeping all account effects specific to that instrument, like a bunch of individuals. To me locked in is when the trade is closed.

Life is a series of risks, no matter what business your in. So long as all the thresh holds are clearly defined in your business plan. That is the size of the risks that can be reasonably expected and managed properly, then its just a matter of getting on with it.