May 3rd, 2016 

On Portfolio Drawdowns

After reading the article: 180 years of market drawdowns, I thought I could add something to it. A different perspective, but nothing contradicting the author's point of view, on the contrary. I found his article interesting.

Portfolio drawdowns are relative, they are relative to the trading strategy used. But one thing is sure, a lot of trades will see some drawdown, more than people think. I opted to use one of my programs to illustrate the point doing a simple test on two stocks I have tested before (see DEVX8 related programs). I just wanted to verify some numbers.

That program trades a lot over the 20-year test period. It has the particularity of having both random-like entries, and exits. Trade performance details are printed on the charts by the program.

To see how many trades suffered drawdowns, it was sufficient to order all the trades by MAE (maximum adverse excursion). This would order all the trades by the amount they lost. Here are the numbers, well, maybe best to give the number of trades that did not suffer from a drawdown. LMT on 3,261 trades had 20 trades that did not go in the red; while LOW with 4,206 trades saw only one such trade. In total less than 0.3%. All other trades saw some red (99.7%) of varying intensity.

For a trade not to go in the red required the randomly selected buy price to be the low of the day the next day at the open, and that the price never went any lower thereafter. So, the probability of that is low, as you guessed, hence the low numbers.

However, all those trades did not necessarily finish in the red. You can see red over the time span of a trade, but only the exit will make it a permanent profit or loss. 

#1  LOW
LOW Chart

 (click to enlarge) 

#1  LMT
LMT Chart

 (click to enlarge)

The trading strategy used was last modified Nov. 29th 2015, making the present tested stocks as if on a 5-month walk forward out of sample test. While the media were touting that the sky was falling, that program was buying shares as directed. Its mission being to accumulate shares for the long term and trade over the process.

The control settings are deem slightly aggressive (but still below mid-range of its linear slope potential), meaning one could extract even more profits by taking a little bit more aggressive stance.

Of all the positions taken (7,467), all were at a profit, either from having been sold, or showing a profit while still in inventory. This is not unusual for this trading strategy. It will do this each time it is near making historical highs. The reason why this is so is also simple: no shares are sold unless there is a profit which easily explains the high win ratio.

The simple fact that you trade, or that your program does the job for you, you will have drawdowns. And as your portfolio increases, so will these drawdowns grow proportionally in dollars.

My stuff is scalable up or down. And, I would add that if I can program something like this, so can you.

Drawdowns are indeed relative, relative to the trading strategy used, plus you can't escape them. So, as the above article concluded: "get use to it".


Created... May 3rd, 2016 © Guy R. Fleury. All rights reserved. 

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