No discussion of trading system evaluation would be complete without a discussion of drawdown. We must always look at the maximum drawdown of any trading system as it is very, very important.
The maximum drawdown of trading system is defined as the greatest peak-to-valley drawdown in a trading systems equity. Lets say for example that we have a trading system that reaches a particular equity peak of $100,000. Lets further say that two weeks later, the trading system equity is at $80,000. In this example, lets say that the $80,000 equity happens to be an equity valley. In that case, the peak-to-valley drawdown would be $100,000-$80,000 equals $20,000. This means that the maximum drawdown is $20,000.
So why is the maximum drawdown such an important measurement in our evaluation of a trading system? Its because the maximum drawdown gives us a measure of the survivability of the trading system. A simple measure, but a measure nonetheless. Basically, when we look at the maximum drawdown we can say that this maximum drawdown can happen again at any time throughout the life of the trading system. This is particularly important when it comes to evaluating starting account...
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