UNDERSTANDING THE RISK OF DRAWDOWN AND INSUFFICIENT MARGIN

Some of these risks are very unlikely to happen, and some of them are possibly even less risky than a stock market investment, but we feel it is our responsibility to point these out and make sure each user understands them before starting to trade a funded account with AlgoLab.

 

  • DRAWDOWN
     

    • When you preview your profit and loss using the Performance Viewer with your capital and risk setting, you will note two metrics: average annual drawdown (Ave an DD), and maximum drawdown (max dd). Average annual drawdown is the average maximum drawdown as a percentage of your STARTING CAPITAL that should expect to happen every year, at some point during the year. Here is an example of a 20% annual maximum drawdown:
       

    • Jan 1 account value = $100,000 (starting capital)

    • May 1 account value = $150,000 (50% return)

    • July 1 account value = $130,000 (drawdown)
       

    • The drawdown is $20,000, or 13% drawdown from PEAK equity of $150,000, or 20% drawdown from starting capital of $100,000. Again me always measure drawdown as a percentage of your starting capital, not from the peak equity prior to the drawdown.
       

    • This does not mean that each year will have a drawdown at some point as large as this value, nor does it mean that your actual maximum drawdown wont be larger than this value. It simply means that this was the average maximum measured during the historical backtest which is hypothetical.
       

    • The Maximum drawdown is the highest drawdown amount in dollars that occurred over the entire historical backtest. If the historical backtest spans 10 years, then you might expect this magnitude of drawdown to occur at a frequency of at least once every 10 years - but it could be more often, or less often. If, for example, after 3 years of trading your $100,000 AlgoLab account, you earned 100% return and your account was valued at $200,000, then on the 4th year your account suffered a maximum drawdown of $30,000, this would represent only a 15% drawdown of your entire account value. However, we never know when this drawdown period will begin, and it is theoretically possibly for this $30,000 drawdown to start the very second day after you open your account with $100,000 of starting capital. In this case, your drawdown as a percentage of your account might be worth 30%.
       

    • Also keep in mind that the S&P 500 stock index lost 50% of it's value in 2008.

Screen Shot 2018-11-09 at 2.30.27 PM.png

This is an example of a MAXIMUM drawdown and an AVERAGE drawdown

  • LOW CAPITAL / HIGH RISK INSUFFICIENT MARGIN
     

    • ​​If you are using one of our 'full' systems that trade all 19 symbols and have the minimum recommended amount of capital in your Interactive Brokers account ($50,000 USD), then there is a possibility that a drawdown (losing period) may start soon after you have started trading. A typical drawdown might be 25% to 30% (low capital accounts) which could reduce the capital in your account to $35,000 or less. At this point, it is possible that Interactive Brokers will periodically reject new trades submitted by your AlgoLab due to insufficient margin available in your account. If the total number of new trades for your account decreases, then this can effect your ability to recover from the drawdown - ie: recovery could be much slower than a fully capitalized account. At this point, there is also the possibility of an extended drawdown which may result in further reduced performance and losses.
       

    • Low capital accounts going through a drawdown which has reduced the amount of available capital to less than $30,000 to $35,000 should either switch to a reduced symbol set trading only 2 symbols, or should be prepared to add more capital to their accounts to prevent IB from rejecting new trade submissions.
       

    • The chance of a severe drawdown starting immediately after the start of trading a new account is low, but this is a possibility and it has happened in the past. The best defense is sufficient capital with a lower risk setting, or being prepared to add additional capital in the unlikely event that a major drawdown consumes a significant portion of your starting capital.

 
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