Does Trade Drawdown Matter?

The single trade drawdown of a strategy DOES matter. Recently someone seemed to express dislike for my strategy How I Invest 1 posting the comment:

and a 54% drawdown… with trades risking as much as 12% of capital:

Link

They also posted the screenshot below highlighting a trade where that cost the strategy roughly 12% of capital.

I have had some good conversations with this user before in other threads and have nothing against them. I am unsure exactly how they intend the statement and screenshot, but I take it to mean they are not impressed with my strategy. I appreciate their concern, but likely would disagree with their view of how problematic it is. Let me explain.

Consider two market participants with different approaches.

1. This first participant is an active day trader that seeks to close out all positions before the market closes each day. This trader uses an average of 20X leverage via futures, but always has a stop loss in place, at 5% of total capital or less.
2. This second participant is a mostly passive investor investing in the Vanguard total stock market ETF (VTI) but will sell shares and tax loss harvest by buying the Vanguard 500 ETF (VOO) when there are losses to harvest.

Investor 1

Since this is a day trader always using stops on very popular futures contracts they likely will never have a single trade drawdown of greater than 5% of capital. Of course, this doesn’t mean they couldn’t have an overall drawdown of 99.9%.

Investor 2

It isn’t hard to imagine a scenario where the second participant buys VTI and the market proceeds to drop 20% over the course of 5 months. Whether they continue to hold it or sell it to tax-loss harvest they will now have a single trade drawdown of 20% of capital.

That is scary but it is virtual impossible for this trader to ever have a drawdown of 99.9% if they stick to the strategy and civilization continues. All bets are off if we get a Zombie Apocalypse 😉

Summary

It isn’t that I am proud to have a 54% drawdown or a 12% single trade drawdown. I would love to have those be smaller numbers, but I do believe that in general if you want to have higher returns you have to take on more risk. No doubt there is a point where more and more risk results in worse returns. But if you want to beat cash, you need to take on the risk of bonds. If you want to beat bonds you need to take on the risk of stocks. If you want to beat stocks, you need to take on the risk of more volatile stocks or stocks with leverage.

Having a 12% single trade drawdown that occurred over the course of 5 months while using a 3X S&P500 ETF isn’t very comparable to a very short-term trader with a 12% single trade drawdown that occurs over the course of a single day etc.

Whether you the reader agrees or disagrees, I hope this helps explain my viewpoint more clearly.

Disclaimer

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