![]() ![]() The more risk that is assume the greater the reward expected. All investment strategies that look for perform above the risk free rate of return will incorporate risk into a portfolio. ![]() Understanding a drawdown that is periodic or based on a peak to trough decline is an important concept toward generating consistent returns. Once portfolio loses more than the planned monthly amount, what should a manager do? There are a number of techniques which include winding down the portfolio, hedging the portfolio or unwinding the riskier portions of a portfolio. In the same way a manager will attempt to keep losses below 20% on an annualized basis, the monthly losses should be geared toward avoiding losses that are more than 1.66%. ![]() With a strategy that is geared toward making 20%, the monthly gains will average 1.66%. On a monthly basis, the drawdown maximum can be flexible but should be aligned with the targeted reward. This percent should be based on how much you are looking to earn, and design a risk management strategy based on this process.Īn investor should consider managing a drawdown on an annualized basis as well as a monthly basis. One of the first items to think about is the maximum loss on a returns basis that you are willing to accept before the strategy is halted and trading is terminated. With this in mind, and investor should think about the possible outcomes from a drawdown and how they should handle trading positions and risk management. The key obviously is to mitigate losses and live to trade another day. Investors are paid to assume risk which means there will be times when trades produce losses. Additionally, a maximum drawdown is a backward looking event, but it can give you an idea of the manager’s appetite for risk.ĭrawdowns are part of portfolio management. Drawdown frequency, as well as the size of the drawdown also needs to be considered. The maximum drawdown is not a perfect measure of risk as it is time dependent. On the other hand, a fund that is generally volatile and produces a large maximum drawdown only reflects the tail risk of this volatility. A hedge fund that boasts smooth gains of 1% per month over a 5-year period that has a maximum drawdown of 20% should produce a red flag. The maximum draw down encapsulates what is considered tail risk which is the risk associated with an event that is unlikely to occur. ![]()
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