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Page 181 Figure 18-4 Maximum Drawdown   Beginning Equity Profit Loss Ending Equity January $20,000.00 $1204.56   $21,204.56 February   21,204.56     485.00   21,689.56 March   21,689.56   8643.25   30,332.81 April   30,332.81 ($1804.59) 28,528.22 May   28,528.22 (2043.23) 26,484.99 June   26,484.99   2451.81   28,936.80 July   28,936.80     539.07   29,475.87 August   29,475.87    968.23   30,444.10 September   30,444.10     392.45   30,836.55 October   30,836.55     890.33   31,726.88 November   31,726.88     145.11   31,871.99 December   31,871.99     309.78   32,181.77 traders measure drawdown, they can determine the amount of cash flowing through their account. Maximum drawdown is perhaps the best indication of the amount of risk inherent in a trader's methodology. It is an extremely important concept for all traders. Unfortunately most novice traders, while acknowledging the importance of maximum drawdown, utterly fail to comprehend its true importance. Figure 18-4 illustrates the concept. To determine your drawdown choose a period of time to examinetypically monthly but sometimes daily. In Figure 18-4 we will look at a monthly summary of all trades over a year. Then begin looking for the first losing trade. Once you have located it, determine equity prior to the loss. In Figure 18-4 the first losing month is April and the equity prior to loss was $30,332.81. Then proceed to the next month, and add the profit or loss to the initial loss. Continue onward until the equity is more or equal to where it was prior to the beginning of the losing month. The largest amount of money that was lost is the drawdown for that periodin this instance $3847.82. Repeat the process with the next losing trade. Once again you will be adding all subsequent gains and losses until all the equity is again recovered. Maximum drawdown is the largest drawdown you experienced over the entire series of drawdowns that you examined. In Figure 18-4 the largest drawdown was $3847.82. The interesting thing about maximum drawdown is that the longer a trader trades, the more valid the drawdown estimate becomes. Unless there are considerable trades and a considerable number of time periods under consideration, then increasing maximum drawdown by a factor of two, three, or more times more realistically portrays a possible future maximum drawdown. In Figure 18-4 the period of time is only 12 months, consequently we should multiply $3842.82 by at least a factor of .2.
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