Try to delta hedge your strategy when you're in a drawdown, you can usually save 50% of your DDs and 2/3 of your max DDs but then you have a slightly lower sharpe and it takes a bit longer to recover.
Come Discuss Systematic Trend Following & Setting Up A Fund
- Thread starter Stratos Capital
- Start date
It seems to me that doing this will inevitably reduce returns.
I must admit I am very unwilling to reduce drawdowns at the expense of returns.
We actually want to differentiate ourselves from the competition, which is so obsessed with volatility.
So the ability to generate strong returns is important to me (of course, without blowing up the account).
The better alternative for me would be to diversify into strategies that are not correlated to trend following (perhaps mean reversion). The idea is that if I can find such a strategy that can generate similar returns and drawdowns.
Then just allocating to both should help reduce drawdowns without sacrificing returns.
What does everyone think?
That's important for most traders. And that's also why they blow up. Although nobody wants to blow up.
Gonna be hard to raise money with these characteristics, especially since these are back tested metrics, not a real track record. My sense is that institutional investors was drawdowns on the order of 10-15%. Also, they would expect at least 50% of general partners PNW to be invested in the fund.
The article talks about trading the equity curve on the basis of a moving average, I'm talking about delta hedging based on peak to valley drawdowns.
As per the article:
" If we're buying insurance, or an option, then there ought to be a cost to it. Since we aren't paying any kind of explicit premium, the cost must come in the form of losing something in an implicit way. This could be a lower average return, or something else that is more subtle. This doesn't mean that equity curve trading is automatically a bad thing - it depends on whether you value the lower maximum drawdown* more than the implicit premium you are giving up."
If you delta hedge based on peak to valley drawdowns instead of moving average, you'll end up with a maximum drawdown that you can set but a slightly lower Sharpe.
Actually it doesn't make any difference which method you use: you end up with the same result (I've checked it- in my previous job we had to use peak to valley on certain guaranteed products).
I think we can agree that any such method will (but might not) reduce drawdown but always at the cost of also reducing returns (which the OP doesn't want to do) [looking at Sharpe isn't ideal, as I said, because applying these kinds of overlays makes the distribution of returns very un Gaussian with non stationary volatility]. And the key point of the article is that this problem is most bad for trend following systems because they tend to have negative auto correlation in returns: bad months tend to be followed by good months - so anything that reduces gearing after losses, regardless of how the losses are identified (moving average or peak to valley) is a bad thing.
GAT
After doing some searching around for ways to reduce drawdowns, I am leaning towards methods that DONT require adding more rules to the system or "predictive" methods that try to time drawdowns.
Methods that seems to be more robust in my opinion include:
1) Studying correlation between markets. Selecting markets that generally do not correlate positively. I admit theres a risk that correlations may break down.
2)Diversifying into multiple strategies. Could be similar trend following strategies, different time frames, or entirely different strategies.
3)Simply diversifying into more markets. I read some CTAs trade more than 100 markets.
Using options strategies, hedging, refining signals, adding more complexity to a trading system, these are things that I try to avoid as much as possible.
Methods that seems to be more robust in my opinion include:
1) Studying correlation between markets. Selecting markets that generally do not correlate positively. I admit theres a risk that correlations may break down.
2)Diversifying into multiple strategies. Could be similar trend following strategies, different time frames, or entirely different strategies.
3)Simply diversifying into more markets. I read some CTAs trade more than 100 markets.
Using options strategies, hedging, refining signals, adding more complexity to a trading system, these are things that I try to avoid as much as possible.
Hey GAT, could you maybe offer some advice on what are the most important elements of risk management at places like AHL?
I am also wondering what are the major pitfalls or difficulties in raising capital?
Because I read that most funds fail in this area. Seems like a good idea for me to start learning about the business part of trading.