Maximum Drawdown:
How High Can it Go?

Controlling or managing our maximum drawdown is obviously crucial to becoming a long term, profitable commodity trader. Unfortunately, drawdown in commodity trading is often not stressed enough, or worse, misrepresented.

The main focus of many trading system developers is to try to maximize profits. How do we know if their systems are over optimized or their markets cherry-picked for the best results?

As well, there are so many available, real-time commodity trading strategy results. How do we know when one is really that good or just currently experiencing a streak of fantastic luck?

A simple, powerful tool developed by Tushar Chande not only answers the above questions, but allows us to compare several different types of trading programs.

In his book Beyond Technical Analysis – 2nd edition; Tushar explains that we can estimate the future maximum drawdown of a strategy or system by multiplying its standard deviation of monthly returns by five.

For example, a strategy with a monthly standard deviation of $5,000 would have a projected maximum future drawdown of $25,000. This formula is extremely useful and usually very accurate.

We now know if we are looking at a program that has an estimated max future drawdown of $25,000 and we want to maintain our drawdown level below 25%, we need to fund our account with $100,000.

Also, if we look at a fund with a monthly standard deviation of $6000 and it only incurred a maximum equity decline of $22,000 to date, we may want to be cautious and expect a future maximum drawdown of $30,000.

Of course, this is only a tool and not a crystal ball. However, it gives us something to work with, which sure beats guessing or being unexpectedly blindsided.

CFTC REQUIRED RISK DISCLOSURE
Futures and options trading involve substantial risk. The valuation of futures and options may fluctuate, and as a result, clients may lose more than their original investment. In no event should the content of this website be construed as an express or an implied promise, guarantee or implication by or from Commodity Trading Solutions, LLC that you will profit or that losses can or will be limited in any manner whatsoever. Past performance is not necessarily indicative of future results. Information provided on this website is intended solely for informative purposes and is obtained from sources believed to be reliable. Information is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted.