There is no sense to judge any trading performance if we don’t take in consideration the drawdown. The drawdown tells us what kind of leverage we can use, and this is very important in terms of speculation. The secret in trading is to avoid big losses and achieve big profits.
DRAWDOWN DEFINITION: The peak-to-trough decline during a specific record period of an investment, fund or commodity.
Do you prefer to have a profit of +100 points with a drawdown of 100 points, or do you prefer to have a profit of 50 points with a drawdown of 10 points?
Obviously, it is better to trade with the second strategy, and the reasons are easy to understand:
The drawdown is the real expression of the efficiency of the trading strategy! It is useless to say we made 200 points of profits when we had a drawdown of 400 points! If we were using a capital of 10k, trading with 1 contract, we probably could not trade anymore because the loss during the trading period destroyed our capital before to be in profit of 200 points, and you know, no capital, no profits!
Whenever someone is telling you the final result of his trading record, you should ask what was the drawdown during that period.
In 2014 we had a profit of 124 points trading the S&P500, with a drawdown of 65 points, a bit high because we had troubles in trading a sideways Market during the year, but we could trade 3 contracts with 20.000 USD, and a final performance of +18.600 USD. If we had a drawdown of 150 points, doesn’t matter the final result because at certain point our capital would have been probably destroyed.
In 2013 we had a great profit of 210 points, with a drawdown of 52
points, which is very good! We could trade with a capital of 20.000 USD,
with a final profit of +31.500 USD!
But we could not start with a capital or 15.000 USD and trade 3 contracts, because at certain point there is the risk we didn’t have money enough to trade with 3 contracts during the year.
In 2015, we are having a profit of 88 points, so far (today is 10th of June 2015), with a drawdown of 24 points, as you can see the drawdown remains always under control, but the profits are constantly growing.
I hope this article helped you to understand why you have to care more about the drawdown than the final profit when someone is providing you investment or trading strategies.
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