Drawdown in the Ideal Trading System

This article elaborates on the one dated August 7, 2006 entitled “The Ideal Trading System”.

Today’s article is about the “draw down” feature. That concerns reduction in the cash balance in your account due to trading losses.

Your system should include a decision as to how much money in total you are willing to lose before deciding to alter or abandon your system.

Given that every system is less than 100% accurate, there is bound to be some losing trades. The order in which losing trades manifest is not determined by the accuracy of the system. For example, let’s say you have a system that wins 8 out of 10 times. You do 10 trades and get 8 winners plus 2 losers. The 2 losers could be in any order out of the 10 trades. They could be the first two, the last two, or somewhere in between the first and last trade.

Giving up on a system after 2 consecutive losing trades would prevent you from having the 8 winning trades in a system that is 80% accurate.

Therefore, your decision as to how much draw down to tolerate depends on the other features of your system including it’s accuracy. If you set it too low, then you’ll be constantly altering or changing systems. That could result in missing out on the winning trades that the same system that you altered or abandoned would have given you.

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Copyright 2006 Raymond T. Lee. All rights reserved.
Leisurely e-Mini Futures Trading
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