Evaluate mechanical systems by peak-to-trough drawdown

Closed-trade statistics do not decide tradability

Common closed-trade statistics such as percent profitable, average win and loss, consecutive losers, hold times, and return on margin are not treated as sufficient to decide whether a mechanical commodity system can be traded.

Maximum equity drawdown, not aggregate profit, is the criterion used to judge whether a commodity system is tradable. Tradability is whether a mechanical procedure can be held through its worst documented equity path without exhausting a stated starting account.

What a six-year historical test showed

In a six-year historical test, 47 of 60 mechanical systems that showed more than 1000000 after commissions and slippage still reduced a 100000 starting equity to zero at some point.

Use the stricter peak-to-trough path

Both close-to-close and later intraday-maximum-equity-drawdown are judged inadequate. Peak-to-trough-maximum-equity-drawdown is presented as the stricter worst-case path. It is measured from the highest open-equity peak in a trade sequence to the subsequent low, then extended whenever a later trough goes lower until a close exceeds the prior peak. The count starts from the furthest favorable open equity and continues to later troughs.

Depending on the system, the peak-to-trough measure exceeded the intraday-maximum-equity-drawdown by 8 percent to 32 percent because the count begins from a positive open-equity peak.

In the bar-by-bar illustration, the accumulated peak-to-trough path reaches 15 points after the first trade, 28 after the second, and 29 after the third, and a close 33 points above the last trough ends that sequence.

Compare systems with an annualized ratio

Systems are compared with an annualized-closed-profit-to-drawdown-ratio. That reading is cumulative closed-trade profit divided by peak-to-trough-maximum-equity-drawdown, then divided by the number of years in the test window. A reading under 2.00 is treated as unsuitable because a large drawdown between two flat stretches can leave a full year negative.

Add a market only if the path shrinks

Adding markets that do not move together can leave closed profits additive while lowering combined peak-to-trough drawdown, which raises the annualized-closed-profit-to-drawdown-ratio and is offered as a way to reduce portfolio drawdown. Portfolio-drawdown-diversification is that combination of markets that do not move together so combined peak-to-trough drawdown shrinks relative to additive closed profits.

Editorial interpretation: consider a second market only after the single-system peak-to-trough-maximum-equity-drawdown path already fits the hard limit, and only when the combined path shrinks.

Bound losses and study what fails

A mechanical commodity system is described as needing defensive stops that bound losses before and during the trade, with evaluation focused on what fails so the procedure can be improved.