Well, to summarize, my 9.17% answer admittedly did not make much sense in that context because your question didn't either. If you want a percentage of something, you first have to tell the percentage of what.

In a performance projection, the drawdown % is a percentage of the profit. I understand that if you lose some amount x, you might be interested in other percentages, such as how much x is in percent of your current capital. But that, although certainly important for you at that point, can not be predicted by a performance projection of a strategy.

Which "rule of three"? https://en.wikipedia.org/wiki/Rule_of_three

And how is it being applied, exactly?

jcl, I appreciate all your comments, but sometimes they do seem to miss and/or avoid the point. Probably because you're too busy single-handedly (mostly) dealing with all the forum posts along with whatever else you do...

I don't understand why you say the 9.17% doesn't make sense. To me acidburn's question made sense, and should have received a sensible answer...

I too am struggling with Drawdown, Return, and how to maximize return and robustness given the requirements of use of capital, etc.

Thanks.

EDIT: My example was not clear about the peak balance. Corrected.

Clearly you guys are in a different time zone to me! I would like to make some notes, but if I am missing the point, please ignore.

Firstly, Acidburn's cited drawdown definition is correct and that's how one would calculate when live trading. It is dependent on the definition of peak...Peak at the start of live trading is the initial balance of your account. Peak at the start of a back test is usually $0.

A similar example. Suppose your system makes $100 / month in the winning months and loses $100 / month in the bad months. Suppose April is going to be a bad month. If you start trading in January with an initial balance of $100, you will have a run up of $300 to peak $400 balance, then a loss in April of $100. So at the end of April your drawdown will be 25%. If you started trading in February with $100, you would have a run up of $100 to $200 balance and then a loss in April of $100. Thus you drawdown at the end of May is 50%. Same $100 drawdown, two different percentages. In a backtest, the initial balance is $0, so in the two examples above, the drawdown would be 33% and 100% respectively. Four different percentage drawdowns.

I believe this is why jcl finds the question to be confusing. Peak prior to drawdown to calculate drawdown percent depends on the initial balance and how much run up you have before the drawdown.

My solution....Personally, I like expressing all trades in terms of R-multiples (another Van Tharp concept.) Your initial stop is how much you will risk (R). Then the losing trades are -1R unless you move your stop further or closer. The winning trades are some positive decimal of R, e.g. +2R. Essentially you are normalising every trade to the risk. This is useful because you can determine the max drawdown in terms of R multiples and apply that to your risk per trade. E.g. suppose your backtest said that the greatest draw down that theoretically occurred was 20R. If you are risking 1% of your account on each trade, then the greatest theoretical drawdown is 20R x 1% = 20%. Therefore at 1% risk, you stand to lose 20% of your account if you go through the greatest historical drawdown in the future.

Problems with this approach - Firstly, your account goes into draw down, your 1% risk should gradually represent smaller amounts. I.e. First loser 1%, second loser 1% of new balance which is 0.99% of original balance, etc. This actually works for you in that at then end of 20 x 1R losers, you are not down 20% from the peak. You would be down about 17.9%. But it is good for getting a feel for risk and where you are on the equity curve.

Second problem, people come up with complex position sizing strategies. jcl even states that the fixed percent model is statistically doomed. So exactly how to apply R-multiples to the model jcl suggests with OptimalF is beyond me. In fact, when Acidburn was trying to understand OptimalF last year, I was totally clueless (one day I will apply myself to that one.)

Finally, this approach is not adopted in any software I know of. I find it odd as it is the way that I view the world of trading. It is the colour of my glasses, so to speak. Yet so many traders (and software) do not record the stop in the trade log. So you don't have a record of what you were risking. Seems strange to me given that this is a risk management game.

Ok, that's my bit. Hope I have helped a little, at least with my explanation of drawdown percent.

There is another problem with the concept of R multiples. It is intended for manual trading when you don't apply much thought where to place the stop, and always put it at a fixed distance. In atomated trading, stops are usually optimized and depend on volatility. So there is no R, and the system risk is unrelated to the stop distance of a single trade.

Hi all.

DMB, not sure who's in what time zone when (except maybe jcl ), or who has what native language, but at least we can all try to communicate! I'll look at your post later - for now want to try to stay closer to current Zorro...

jcl, I'd appreciate your help with a few things:

a) The manual describes Capital Required (non-reinvest) as the sum of normalized Drawdown and maximum Margin. It describes Annual Return as annualized profit divided by the sum of normalized Drawdown and average open Margin. Why the difference? In other words, why isn't Annual Return calculated as annualized profit divided by Capital Required - presumably the starting capital that return should be based on?

b) I understand your simple ratio calc above to get the 9.17%. I understand that Drawdown % can't be based on an equity value. I understand that total profit is available for an easy calculation, and I can see the usefulness of this % as a measure of the strategy's performance. However, this % has no relevance to strategy expiration, correct?

c) Assuming a strategy is started with the Capital Required, there is some worst-case, small but non-zero probability that it will go margin call immediately, correct? Therefore, should a strategy be started with the Capital Required (CR), 2*CR, or some other amount?

d) If I understand your explanation of strategy expiration, you're comparing actual drawdown with Tested drawdown (not to be unnecessarily confusing, but possibly via the % the former is of the latter), correct? And expiration is triggered when actual drawdown > Tested drawdown (i.e., (actual drawdown / Tested drawdown) > 100%), correct? And to provide the "headroom" for this w/o getting a margin call, the strategy must be started with an investment >CR by some amount (%)...

e) Lastly, for Risk tolerance, if I'm at 20% and there's some small chance a strategy could go full drawdown right out of the gate, then I need to start it with an investment of 5*CR, correct?

Thanks.

a) The return is calculated for the highest likeliness, while the capital is calculated for the worst case. Therefore the average margin is used for the return and maximum margin for the capital. Early Zorro versions didn't use the margin for the return calculation at all.

b) Yes.

c) That is up to you - I normally use CR, but 2*CR is certainly safer. But I would stop a system anyway when CR is lost.

d) Yes, correct.

e) Normally not. Going down to 20% of the CR right at the start is rather unlikely, and could be a sign of expiration of the strategy. In that case it would be better to prepare for terminating the system when it goes down further, instead of investing 5*CR.

Thanks jcl.

a) I don't understand what you mean by "highest likeliness"? If the CR is what I start with, it's 100% likely , and the return should be based on it.

c) If a system is started with CR and it's lost, that's margin call, isn't it?

e) If my Risk tolerance is 20%, I don't want to lose more than 20%. Therefore, I don't want my account going below 80% CR. How likely is <80%CR? Is there a probability curve for drawdown as a % of CR? Linear? S?

a) The return of highest likeliness is defined as the average of all possible returns.

b) Yes. This way the problem solves itself, sort of.

c) Such a curve could theoretically be calculated, although this is not trivial. The Ulcer Index gives a hint as it measures the % of the profit that you'll lose in an average drawdown.

I would think as a percentage of balance peak rather than equity.

Since DD$ is the difference between a balance peak and the lowest subsequent equity valley in account currency units, it would be nice to also have a DD% as the difference between a balance peak and the lowest subsequent equity valley as a % of the balance peak used to calculate DD$.

This, for example, is how myfxbook calculates equity and would be useful for comparing live trading DD results to test DD where the starting capital is different.

If I understand correctly, the DD% that Zorro gives is a % of the final gross profit (not the gross profit at the time of the DD).

Correct, Max DD % is always a percentage of the gross profit of the simulation.

Using a balance peak instead would be not much better than acidburns idea of using an equity peak: Suppose your simulation starts with the first trade winning $10, the second trade losing $20 - a rather normal situation. This would be then a 200% drawdown, regardless if all subsequent trades are won.

Myfxbook is no trading simulator and does not calculate a DD projection at all. It just tells you your current DD. If I'm not mistaken, it also displays the max DD % as a percentage of the profit.