Causes of Drawdown

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fab1usa1
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Causes of Drawdown

Post by fab1usa1 » Sat Jul 02, 2011 9:16 pm

Good People,

Please help me understand why a seemingly good system would go through a prolonged 50% drawdown.

Having never personally lived through one of these, I am trying to envision the circumstances that would drive such a downturn in performance.

I can understand exogenous events like the bursting of the tech bubble, 9/11, bursting of the credit bubble, the flash crash, etc.

I can understand why a trend following system would stop working in a market entering a consolidation period.

I CANNOT understand why a trend following system would suddenly stop working in a trending market.

Thanks,
Brian

PS: Sorry for putting this post under Money Management. My first choice was Questions and Answers but that forum was locked.

rhc
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Post by rhc » Sun Jul 03, 2011 10:16 pm

Please help me understand why a seemingly good system would go through a prolonged 50% drawdown.

Having never personally lived through one of these, I am trying to envision the circumstances that would drive such a downturn in performance.
Since you have said it’s a “goodâ€

fab1usa1
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Post by fab1usa1 » Sun Jul 03, 2011 10:51 pm

Thanks for your reply, rhc.

I have a VectorVest background (still use it for stock screening and backtesting occassionally).

I learned to mitigate risk by exiting the market, or at least not replacing closed positions in my portfolio, when the market timing indicators turn against me. This has the effect of reducing maximum drawdown.

Interestingly, when your reply came through I just finished reading a white paper by Eric Crittenden of Longboard Asset Management where he explains a system of buying stocks hitting an all-time high and exiting on a 10ATR trailing stop.

I used VectorVest backtester to approximate Mr. Crittenden's system. I am seeing a max drawdown of 53.24% from 12/31/1999 to present day. When I overlay the market timing indicators on the equity curve I see steep drawdowns during those time periods when I would normally be sitting on the sidelines.

I would be very interested to hear everyone's feedback on using market timing indicators in trading systems. Just to be clear, I am talking about timing indicators on the total equity market, not on individual stocks.

Chris67
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Post by Chris67 » Mon Jul 04, 2011 4:12 am

Think your hitting on some really important issues here - why would a good system stop working - when markets are still trending
The only answer to that is that the "nature " of the trends has changed - which it has - they are so whippy and hence a longer term time frame is probably best
I recently incorporated an ultra l/t system into what Im doing - average holdimng period = 600 days for winning trades
Its interesting to see the stops on this system vrs some of the other sytems Im running - for example in Gold its stop loss is below 1000 - I can more or less guarantee IF Gold HEADS THROUGH 1000 the uptrend as we know it for now is probably over
All my other systems have stops between 1350-1450 area - when I look at the chart i could see Gold hitting 1400 and going back up and an uptrend is still nicely in place
So really it comes down to the time frame - ttry running lots of time frames and combining them all to cover your bottom

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