Drawdown simulation and trading systems selection

palm

Newbie
8 0
Method
Suppose i have a trading system A which has historical 100 trades data. I ran simulation 10,000 trials and look at the worst drawdown that this system A could have produced by chance alone. Let's say that

System A has max simulated Drawdown (DD) at -40%. Now if I set my maximum drawdown of my portfolio at -20%, i will be trading system A by only half of my portfolio to ensure that when the worst comes, i

won't be down more than -20%. By the same token, if system B has max simulated DD of -10%, i will be trading 200% of my portfolio on system B.

Questions:
Currently I set every system that i have equally at -20% max portfolio DD. Here's what i mean

System/ Max Simulated DD/ Portfolio Max allowable DD/ Market exposure adjustment % / Annual Expected Returns (100% market exposure)
A -30% -20% 70% 36%
B -63% -20% 33% 24%

For example, if i have $100,000 portfolio, i will trade system A at 70,000 market exposue in a given trade. And i will trade only $33,000 worth of market exposure on system B. This also mean that my expected

returns will be geared down accordingly. So system A will now have expected returns to my portfolio of (36%*70%) = 25.2%. And system B will give me 7.9% returns to my portfolio.

Now here's my question, by setting each system max DD to -20% of the total portfolio, i am willingly allow each system an equal chance of damaging my portfolio. You would ask, why should i allow system B

which can generate only 7.9% returns to my total portfolio to have the same damaging effect on my portfolio. In other words, should i set B at -15% instead of -20%? How about setting A at -25%? What should

be my method in setting this Portfolio Maximum Allowable DD when i take into consideration the expected returns of each system?

Any comment is welcome.

Thank you
 

palm

Newbie
8 0
Method
Suppose i have a trading system A which has historical 100 trades data. I ran simulation 10,000 trials and look at the worst drawdown that this system A could have produced by chance alone. Let's say that

System A has max simulated Drawdown (DD) at -40%. Now if I set my maximum drawdown of my portfolio at -20%, i will be trading system A by only half of my portfolio to ensure that when the worst comes, i

won't be down more than -20%. By the same token, if system B has max simulated DD of -10%, i will be trading 200% of my portfolio on system B.

Questions:
Currently I set every system that i have equally at -20% max portfolio DD. Here's what i mean

System/ A B
Max Simulated DD -30% -63%
Portfolio Max allowable DD -20% -20%
Market exposure adjustment % 70% 33%
Annual Expected Returns 36% 24%

For example, if i have $100,000 portfolio, i will trade system A at 70,000 market exposue in a given trade. And i will trade only $33,000 worth of market exposure on system B. This also mean that my expected

returns will be geared down accordingly. So system A will now have expected returns to my portfolio of (36%*70%) = 25.2%. And system B will give me 7.9% returns to my portfolio.

Now here's my question, by setting each system max DD to -20% of the total portfolio, i am willingly allow each system an equal chance of damaging my portfolio. You would ask, why should i allow system B

which can generate only 7.9% returns to my total portfolio to have the same damaging effect on my portfolio. In other words, should i set B at -15% instead of -20%? How about setting A at -25%? What should

be my method in setting this Portfolio Maximum Allowable DD when i take into consideration the expected returns of each system?

Any comment is welcome.

Thank you
Sorry i messed up the table
 

meanreversion

Senior member
3,398 535
I think there's a danger of overanalysis here. Try looking at the profit to max. drawdown ratio in your backtests. If it's 2-3 or higher, then the system should be ok.

HOWEVER it does depend on the timeframe over which you run your tests. P:MD ratio goes up and up the further back you run your test, provided the strategy is consistently profitable. But it is a useful way to quickly compare strategies.
 

Tuffty

Well-known member
442 8
Instead of max drawdown to return ratio it may be better to use a drawdown level where there is a higher level of reliability (ie where you've got more stats for). For example on the run of 10,000 trades look to see where say 95% of drawdowns ended and use that in the ratio.
 

No one Knows

Member
68 9
Whatever results you calculate for any system are going to be "ideal" situation, if you were to follow your system and execute exactly to the letter and take every possible trade. Which is never going to happen in practice. Whatever you calculate for profit half it and double the projected drawdown and if you can live with those results then anything better would be a bonus.

Why you would want to use system B at all if you had system A is not clear unless it is negatively correlated to system A to smooth equity curve maybe?


:eek:nline2lo
 

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