Maximum drawdown

[pkfryer]

Whats your understanding of the term Maximum Drawdown and Maximum Run-up?

Is it the maximum fall of equity from the highest point? E.g. if the highest point is 20K and its currently at 15K, the maximum draw down is 5K.
Or is it the maximum drop in equity throughout the history of the equity? e.g. if 2 years ago the equity fell 6K but subsequently rose 20K higher, the 6K would still be the maximum draw down?

And maximum run-up is what? The biggest unbroken rise in equity before a 'correction'? Would the run-up end the moment there is any form of draw down no matter how small?

Also, how useful do you think this is as a backtesting statistic? Would you use the statistic to gauge risk and position sizing? Or as a means to put the breaks on when the maximum drawdown is exceeded in current trading?

 

[pogle]

Whats your understanding of the term Maximum Drawdown and Maximum Run-up?

Is it the maximum fall of equity from the highest point? E.g. if the highest point is 20K and its currently at 15K, the maximum draw down is 5K.
Or is it the maximum drop in equity throughout the history of the equity? e.g. if 2 years ago the equity fell 6K but subsequently rose 20K higher, the 6K would still be the maximum draw down?

And maximum run-up is what? The biggest unbroken rise in equity before a 'correction'? Would the run-up end the moment there is any form of draw down no matter how small?

Also, how useful do you think this is as a backtesting statistic? Would you use the statistic to gauge risk and position sizing? Or as a means to put the breaks on when the maximum drawdown is exceeded in current trading?

My understanding of maximum drawdown is the maximum fall in value over the history of your strategy. So, if at some point a strategy results in a pot of 20K and the pot subsequently falls to 15K then recovers, the maximum drawdown is 5K. If the pot then goes on to reach 25K it needs to fall to below 20K to set a new level of maximum drawdown.

I think it's useful because I always think of it as "How big does my pot have to be to trade this strategy?" because if the drawdown starts on the first day you trade it , then that's how much you'll need (plus globes of steel) to stay in business. I always calculate a strategy's theoretical return based on this figure. I am currently trading a strategy that has recently set new levels of drawdown. It takes some b*lls to stick with it when that happens!

I've never heard of Maximum Run-Up, but you're suggestion seems reasonable.

 

[Trader333]

I have always considered maximum drawdown to be the biggest fall in an account balance during the life of the strategy. It is usually measured in percentage terms which makes sense because as an account increases in value the amount risked per trade would traditionally go up but the percent risked would stay the same.


Paul

 

[fseitun]

I like to calculate my maximum drawdown and multiply it by 2 before I decide to start using a new strategy.

Fir example, say your max drawdown is a 10% loss of equity based on stats and backtesting.

I take that number and multiply it by 2, thus my max drawdown is now 20%.

I do that for a simple reason: many times in real trading you'll have to face a new max drawdown and most of the times traders are unprepared to survive such a loss.

Perhaps I am a little too conservative but I feel comfortable with it and I rarely get caught off guard when a drawdown comes along.

 

[fdutine]

Hi pkfryer, Hi Forum!

Maximum run-up is actually just the opposite of the max. drawdown. Thus, it is the highest constant gain until the "correction" - I assume, that's what you had in mind anyway.
Just to make the whole story a little more clear, please find simple calculations in my Excel file attached including:

1. Maximum Drawdown
2. Maximum Run-Up
3. Maximum Drawdown length

Regards,
Frank

 

[Straddle8]

Whats your understanding of the term Maximum Drawdown and Maximum Run-up?

Is it the maximum fall of equity from the highest point? E.g. if the highest point is 20K and its currently at 15K, the maximum draw down is 5K.
Or is it the maximum drop in equity throughout the history of the equity? e.g. if 2 years ago the equity fell 6K but subsequently rose 20K higher, the 6K would still be the maximum draw down?^

The maximum drop in eq throughout the history of the eq. If your start with 5K and then it goes down to 2K and later it ends on 20K ==> Max DD = 60%.
Following such a strategy would mean you'd have to bear a 60% loss in equity at the worst point.

I have also seen other calculations, so I guess you can pick a calculation that fits your needs.

And maximum run-up is what? The biggest unbroken rise in equity before a 'correction'? Would the run-up end the moment there is any form of draw down no matter how small?

In the case above, the high during the trade - starting point.

Also, how useful do you think this is as a backtesting statistic? Would you use the statistic to gauge risk and position sizing? Or as a means to put the breaks on when the maximum drawdown is exceeded in current trading?

It's probably the most usefull backtesting statistic I've seen. I use the MAE and MFE derivations from John Sweeney. Suppose I backtest a moving average over a 10 year period on the S&P500. This would give me a sample with, let's say 500 trades. You can then make two colums, one for the winning trades and one for the losing trades. You could then use the MAE statistic to calculate a stop-loss percentage to cut your losers short, and still letting your (biggest) winners run.

 

[meanreversion]

Wikipedia has all the answers.

MDD = 0
peak = -99999
for i = 1 to N step 1
if(NAV > peak) then peak = NAV
DD = 100.0 * (peak - NAV) / peak
if(DD > MDD) then MDD = DD
endfor

(very elegant)

http://en.wikipedia.org/wiki/Drawdown_(economics)

 

[Straddle8]

Thx for that link.

And also for that lovely spreadheet!

 

[hokid]

I like to calculate my maximum drawdown and multiply it by 2 before I decide to start using a new strategy.

Fir example, say your max drawdown is a 10% loss of equity based on stats and backtesting.

I take that number and multiply it by 2, thus my max drawdown is now 20%.

I do that for a simple reason: many times in real trading you'll have to face a new max drawdown and most of the times traders are unprepared to survive such a loss.

Perhaps I am a little too conservative but I feel comfortable with it and I rarely get caught off guard when a drawdown comes along.

Good idea, I learn a new thing, thanks.