Basic Understanding of Maximum Drawdown
FX automated trading, the double-e here is the Reiwa era’s actual double E (EA) developer.
There is a “Maximum Drawdown” item in backtests.
This is an important criterion when choosing an EA.
This time I will write about maximum drawdown.
① In simple interest backtests, you do not look at the %
② Just because it’s low doesn’t mean it’s good
③ Recovery factor matters
④ If possible it should be displayed in yen
I will write articles about these four items like this.
Regarding ①
In simple interest backtests, of course the lot size is fixed.
Unlike compound operations, regardless of how much margin you have, you trade with a fixed lot.
…In other words, the larger the initial margin, the lower the backtest maximum drawdown % will be.
Therefore, for simple interest backtests, you should not look at the maximum drawdown %!
You must look at the amount instead.
(A Holy Grail EA with maximum drawdown under 1%! such claims are totally unreliable)
② Regarding
And,
Maximum drawdown is something you would look at in simple backtests for the amount, but
it depends on how many lots you tested with.
For example, with 0.1 lots and 50,000 yen, it would be 5,000 yen at 0.01 lots.
You need to see the maximum drawdown amount for the test conducted with how many lots.
(Even an EA claiming a maximum drawdown of only 5,000 yen is not trustworthy)
③ Regarding
Well, suppose the maximum drawdown is 50,000 yen at 0.1 lot.
Is this EA a good EA?
That alone isn’t enough to tell.
How much pure profit is important.
(1) Maximum drawdown 50,000 with net profit 500,000
(2) Maximum drawdown 50,000 with net profit 1,000,000
…In these two, I would certainly choose (2).
However,
Backtests of commercial EAs have varying maximum drawdown and net profit,
and you may not know how to compare them!
…That’s why there is a metric called “Recovery Factor.”
Calculation is simple: “Net profit / Maximum drawdown”.
The higher this value, the more excellent the EA.
Generally for backtests over 10 years, you’d want a recovery factor of at least 10.
In this case,
The recovery factor per year is 1, meaning
If a maximum drawdown occurs, you can recover within one year.
If over 10 years you have net profit 1,000,000 and maximum drawdown 50,000, the recovery factor is 20.
If over 5 years you have net profit 1,000,000 and maximum drawdown 50,000, the recovery factor is also 20.
※ In other words, it depends on the backtest period.
※ Therefore, when you calculate the recovery factor, you should convert it to per year or standardize the period.
However, backtests should be compared over 10 years or more.
Even if the last five years look good, the next five years may be terrible.
Please consider 10 years or more as the standard.
④ Regarding
Suppose in one EA’s backtest the maximum drawdown was 50,000 yen.
Meanwhile in another EA’s backtest it was 500 dollars.
Are these two EAs experiencing the same amount of maximum drawdown?
What is the yen equivalent of 500 dollars?
If 1 dollar = 100 yen, that’s 50,000 yen.
If in 2024 1 dollar = 150 yen, the maximum drawdown would be 75,000 yen.
If in 2011 1 dollar = 75 yen, the maximum drawdown would be 37,500 yen.
Even with the same 500 dollars, it can vary by more than double,
which is quite a lot!!
Even if you say maximum drawdown is 500 dollars, you don’t actually know how many yen that is.
In other words, since we trade in Japanese yen,
it’s better for backtests to be displayed in Japanese yen terms.
So,
please keep this in mind.
Well then!
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