Maximum DrawDown

S

Shiva

I have a question about MDD (maximum drawdown).

If my system generates a signal for a security and you initiate a position (either long or short) in that security, if the security keeps on moving in the direction that is favorable to your position, how do you calculate the MDD? Will the MDD be negative or positive? My guess is that it would be positive because the valley point is the initial postion. And positive MDDs are good. Am I right?

The next question is how useful is MDD if you have a predetermined stop loss in place? Since your stop loss gets hit before the maximum draw down is encountered (and hopefully your system generates another signal to move in the reversed direction to take advantage of the changed direction), what is the use of MDD in this case?

Or is MDD only useful to determine the risk of a security? If so, are we not better off using standard deviation?

If I am wrong in any of my suppositions, please let me know followed by detailed explanation.

Thanks.
 
drawdown is your highest equity balance minus your present equity balance and you would keep track of those on a daily basis. max drawdown would be the largest drawdown you have ever had in your live trading or historical backtesting. it a good number to be aware of so that you can determine if you have enough guts to withstand that kind of loss which usually takes place over a certain period of time. its kind of a hard question to answer until you are in drawdown to know what feeling of fear you are going to experience, but a good starting point.
once you have reached your last highest equity high, you are out of drawdown and the new high then becomes the new bencmark to measure against.
just my thoughts.
pat
 
It appears that I tried to compute MDD for a given security instead of a portfolio with a bunch of securities. No wonder, I was confused! Indeed MDD has no business in invidual security because stop loss will take care of that.

Thanks for the answers.
 
Quote from Shiva:

It appears that I tried to compute MDD for a given security instead of a portfolio with a bunch of securities. No wonder, I was confused! Indeed MDD has no business in invidual security because stop loss will take care of that.

Thanks for the answers.
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No. If you track your trading, or backtest for a long period of time, and accumulate enough trades then I expect to see losing trades and losing streaks. The losing streak is a drawdown.

Trading individual securities can produce drawdowns.

If you stop a loss then the loss is part of a drawdown.
 
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