It is meaningless to talk about trading profits without also mentioning the drawdown incurred along the way.
A 20% annual return might seem admirable on the surface, but experienced traders know there’s a big difference between achieving it with a 30% drawdown, versus a 10% drawdown.
The latter is impressive. The former, not so much.
So… why is this important?
Because a person who achieves a 20% return is not necessarily a good trader… if he undergoes a 40% drawdown (as an example).
Making a million dollars is not necessarily a good thing, if you lost two million dollars along the way.
In trading, at least, the important metric is therefore not the total profit, but the ratio between profit and drawdown. (One measure of this is the Sortino ratio.)
Industry professionals all know this. They understand that it is pointless to talk about returns without also referring to the drawdown.
So if you see anyone talk about achieving high returns and conveniently leave out the drawdown, beware. You are probably dealing with an amateur or a charlatan.
So what is the drawdown, then?
Hi Paul, this page might help.
Thanks, that’s interesting.
I always thought that if someone said they had a 20% annual return, it meant the value had increased 20% in the year or years.
Obviously not, then!
Hi Paul, yes a 20% return means that the capital grew by 20%. However, it’s important to note the amount of risk (drawdown) the account was exposed to in the achieving of that return.
Chris, is there any such thing as a maximum acceptable draw down?
Maximum drawdown for most prop firms (if you want to get hired) is 4% – so from the standpoint of professional companies wanting you to trade their money, that could be considered the maximum.
Hi Okeke,
Yes there is. Depending on the firm/investor and capital amount, it ranges from 4% – 20%.