Wednesday, April 13, 2011

Mr Portfolio's Drawdown.

Hey there,

Sorry this post took so long, its 11.45pm now so technically its still Wednesday haha. Its been such a busy day and I had just came back from having dinner. The post was only half written so I’ve just finished typing it up.
Here it goes!

So a patient came into the emergency department last Tuesday, his name was Jeff Sia’s Trading places portfolio. He prefers to be called Mr. Portfolio. He walked in with a small wound on the chest, we padded him up and he looked beautiful on Tuesday at 4pm. Then all of a sudden on Wednesday he started bleeding profusely. We tried to manage his bleeding but he just kept bleeding and bleeding and bleeding.

Today he went into shock and has been admitted to the ICU for resuscitation and monitoring. He needs a few units of packed red cells (cross matching has been done), some IV fluid, a high flow oxygen mask, the anaesthetist has been notified so that if things get worst we’ll intubate him and put him on mechanical ventilation. For some reason the bleed is getting worst. A FBC, LFT, and UEC has been requested, we are waiting for the results.

On initial assessment, it looked like a minor trauma probably by a projectile object. On further examination it looks like it is a gunshot wound. The patient could not communicate so he couldn’t tell us what had happened. But after a few investigations and scans were requested, it looks like a bomb had exploded in him. The surgical team has been notified so that they can come and make an assessment.

That sums up the story of Mr Portfolio. What are your management plans, doctor? What further investigations will your request, what are your impressions and differentials and what is your priority at the moment.


I’ve always been a more conservative trader, focusing mostly on the ASX 200, using a mixture of moving average crossovers, Darvas Boxes and intrinsic value calculations. Usually no more than 20% of my portfolio goes to small caps and penny stocks. However for Mr Portfolio, I’ve decided to go nuts and not worry about risks, well because it is a game and the money you lose in the game does not really matter and it is good practice.

A big thing that comes with trading especially with more volatile shares is managing downside and capital preservation. Of course with volatility, traders will face drawdowns almost inevitably. A drawdown is any losing period during an investment record. It is defined as the percent retrenchment from an equity peak to an equity valley. So if you have 220 000 and you drop down to 200 000, the drawdown is 9.09%, which is the case for Mr Portfolio.

Another thing to have in mind when losing money is how much do you have to make to break-even. So if you lose 10%, how much do you have to make to break even? 11%. If you lose 50%, you’ll have to make 100% just to break even. To add figures to that example, if you have 100 000 dollars, and lost 50% of it, you’re left with 50 000. So to bring your portfolio back to 100 000 from 50 000, you’ll have to make a profit of 100%.

Below is a drawdown recovery chart that I got from the book Trend Following written by Michael W. Covel. Definitely check out and buy this book if you want to learn more about mechanical trading and trend following.

Top traders will have these numbers in their head, so they know how much they have to make in order to break even. With these numbers in mind, they then estimate the risk they are willing to take, their position sizes, etc.

I guess for us beginners, it is important to remember that drawdowns are inevitable. Even the best traders in the world face massive drawdowns. It becomes worst when investors lose confidence in them and pull their funds out. The best we can do is probably to stick to our investing or trading strategy, maybe modify it a bit if you’ve identified some weaknesses and ride the drawdown.

For Mr Portfolio, my confidence really took a hit when I saw his condition today. I mean losing more than 20 000 in 4 days is a lot. I guess its not that much if you compare to the drawdowns that some of the top traders face but for me it is a fairly large number. Even with strategies in place and rules to follow, it can really make you doubt your trading decisions.

But like I’ve said in my older post, if you stick to one of the most basic rules of trading, cut your losers and let your winners run, your next winning position should cover your losses.


So tell me a bit about your experience with drawdowns. How have you felt, psychologically because drawdowns can be very stressful. What have you done when faced with a big drawdown?

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