Avoiding drawdowns (Part 2/2)
STUDY 1: Percent winning trades triggering INCREASE / DECREASE IN LEVERAGE (RISK)
A week ago, I published a study that found a weak link between increased AlgoLab performance (decrease in risk/reward ratio (G/P)) and a recent string of both winning trades, and losing trades. if there is a good % of winning trades recently, then GP improves if risk is increased. If there is a large % of losing trades over a much longer period of time, then GP also improves if risk is ALSO increased. This is logical, and basically says that when the % of profitable trades starts to increase, that it will continue. This also says that if we have been going through a long drawdown period, it can make some sense to increase risk to catch the equity "bounce back" when market conditions start to revert back to normal once again.
However, I DID NOT find sufficient evidence required to build these new filters into the trading systems. The findings were very weak, but they are there.
STUDY 2: Percent winning trades triggering a TRADING PAUSE / UNPAUSE
This study was similar to the previous study, except that I was looking at the effect of suspending trading (PAUSE) after a recent increase of % winning trades, and also suspending trading after a recent increase in % LOSING trades.
Results of study 2
I found weak evidence that when the % of winning trades increases to between 48% to 60% wins over a long period of between 100 to 200 previous trades followed by a suspension (PAUSE) of trading for between 50 to 300 next trades, the GP ratio improved marginally.
I also found weak evidence that when the % of winning trades DECREASES to between 5% to 10% over a period of between 10 to 20 previous trades, followed by a suspension of trading (PAUSE) of between 10 to 80 next trades, the GP ratio also improved marginally.
Generally speaking, since it is very difficult to predict how long a winning streak, or equity run-up is going to last, we do know that the longer it continues, the more likely a drawdown will occur next. if you can time a pause near the top of an equity run-up (or reduce your leverage (risk), then you may be able to avoid some of the subsequent drawdown.
Also, if we have been going through a drawdown, it does make some sense to UNPAUSE trading in advance of the next equity run-up period (or increase leverage (risk) - assuming you can "time" (guess) when the equity peak will form.
As I said above, the evidence is weak (but somewhat consistent). Acting on these ideas may or may not improve your results beyond that of simply leaving the AlgoLab systems running on auto-drive.