May 3, 2016

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 most 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 by 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 might have 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 (99.7%) saw some red 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 to never go any lower thereafter. So, the probability of that is low, as you might have 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)

#2  LMT

LMT Chart

 (click to enlarge)

The trading strategy used was last modified on 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 was to accumulate shares for the long term and trade over the process.

The control settings are deemed slightly aggressive (but still below the mid-range of its linear potential), meaning one could extract even more profits by taking a little bit more of an 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-cited article concluded: "get used to it".

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