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Drawdowns in the Dax Day Traders..... where's the line in the sand?

October 30, 2006


What's happening with the Dax day trading systems ? These auto-executed systems working on direct price links with the Eurex futures exchange burst onto the scene at the beginning of 2006, bringing with them a fine pedigree of successful post release testing and positive returns in real time trading.

Phi Plus Dax gained over 45% in May, while Beta Dax v2 and Rayo Dax both were both in double digit returns that month as well , gaining 17% and 14% respectively. But fast forward a few months into September and October, and we see each of these programs struggling a little bit as the volatility in the Dax futures market has fallen to about half the value it was in June. (see chart below)

Dax Prices in past 12 months

Dax Volatility in past 12 months.

52 Wk High = 120__ Current = 66

This declining volatility has been part of the reason each of the aforementioned programs (Phi Plus, Rayo Plus, and Beta Dax v2) has moved into new max DD territory for the time period since trading began at Attain.

The numbers don't look all that bad - with each of the three systems still in positive territory for the year as of the end of September. But the systems have drawn down significantly from new equity highs made in May, August, and July, respectively. The Rayo Plus Dax system has seen the biggest pull back, losing 37% in the past three months (including Oct.) since hitting new equity highs in July. Next is Phi Plus, with a drawdown of approximately -33% since posting profits of +45% in May which has lasted 5 months. Finally, Beta Dax V2 is just two months removed from its last equity high in August, but with a DD of -31%.

But many investors want to know…..Is it time to worry? Is it time to stop? The short answer is: it is definitely time to worry (nobody likes losing money), but the long answer is it's not that close to being time to stop. The rule of thumb is to always expect the worst drawdown will occur in the future. But this begs the question - when faced with a new max drawdown, when should you stop trading this or any other system?

Setting a "Line in the Sand"

At the risk of sounding too vague, the question of when to stop trading a system is a personal one. Each investor utilizing these Dax systems, or any system for that matter, should have a "line in the sand" which they will not go past. This is not the Nasdaq in 2001. We're not interested in trading something all the way down to zero, thus it is extremely important to know what your max loss point is BEFORE getting involved with a trading system.

But where do you set that line in the sand? Usually not a the pre-tested Max DD, as we can expect that a new Max DD will occur in the future. But then how far past the old Max DD. What is a normal excursion beyond the previous max drawdown, and what level of new drawdown might signal that the system is "broken" and should be reevaluated?

Let me first say that system's don't "break". No system starts throwing out rogue trades and losing more than it was designed to because of some broken logic or flawed code. (At least no system executed for clients at Attain). I believe what many investors refer to when saying a system "breaks" is when the risk profile moves severely outside of what was expected in first getting into the investment. If one of the premises for investing in the system was a Max DD of only 40%, for example, then the possibility of future drawdowns of 75% should cause the investor to reevaluate.

So if systems don't break, what do they do? They simply become much more risky. So reevaluating your system investment doesn't necessarily mean stopping it, rather analyzing whether you're comfortable with the added risk. The new profile of the system may simply mean a higher allotment of capital to the system or a reduction in exposure to the system (i.e. 2 contracts down to 1). If the system's overall metrics remain very good, stopping a system simply because it has eclipsed its max DD could do more harm than good. For example, the Compass system was in similar territory in the middle of 2004, only to come roaring out of the Drawdown to post new equity highs three times in 2005.

Measuring Future Drawdowns:

But let's return to the question of where should you put that line in the sand? How far past the old drawdown is too far past? Attain Capital has several statistical methods to calculate the "line in the sand", but setting the bar at 1.5 times the predetermined, tested, historical drawdown is a good starting place that gives a system plenty of "breathing room". Using the 1.5 times max DD level, each of these systems is over 10% away from any serious thought of stopping trading.

The 1.5 times the past historical DD admittedly has issues in so far as it has no statistical basis. (Why not 1.35 times, or 2.4 times, etc.), and for that reason Attain uses several other measures to measure expected future drawdowns. Again, we should always expect a new max DD in the future, thus want to be prepared for that eventuality when it arrives by calculating an estimated future drawdown.

The first method of measuring a possible future max DD was to run a Monte Carlo simulation using monthly return data. The simulation, run 5000 times over 1200 months (100 years), randomly shuffles existing data to give probabilities of future drawdowns exceeding certain levels. Using the Phi Plus Dax system as an example, we plugged in all of the hypothetical backtested results prior to the system's release, and our simulations told us that 99% of the simulation trials saw drawdowns less than 48.00% or ($15,840). This tells us that the current drawdown of ($10,890) is still about $5,000 below the "line in the sand" generated using a Monte Carlo engine. For more information how Monte Carlo simulations work, see our past newsletter on the subject using this link:

The next method was to run an empirical test on available data using the mean, standard deviation, and skew of monthly returns to calculate a drawdown estimated to occur with a 1 in 100 year frequency. These tests allow us to calculate both a Max DD in dollar terms and an estimated max drawdown duration. Using the Phi Plus system again as an example, the empirical test showed we are again below the 1 in 100 year levels, with the estimated future max drawdown (or stop trade point) still about $6,400 away.

Finally, we put the six sigma test into effect. To achieve Six Sigma confidence, a process must not produce more than 3.4 defects per million opportunities. Six Sigma standards are common in the production of microchips and high level security software, where the margin for error is razor thin, and in short insures there are six standard deviations between the mean and the nearest specification limit. In trading systems, the mean is your average drawdown, and the specification limit is the max DD you never want to see. The Six Sigma "line in the sand" for our example system, Phi Plus Dax is a Max DD of -42.05% or ($12,616), which gives the current drawdown another $2,000 or so to go.

So here we stand, with all three of these Dax day traders at new Max DD levels for the year. By all accounts, it is worrisome, especially given the low readings on Dax volatility. But, as shown in the table below, the additional risk between the current DDs and the stop trade point for each system has between $1,100 and $7,300 to go before reaching the average drawdown levels we use as potential "lines in the sand" for stopping trading, and all are well below the maximum stop trade level an investor could use. .

The table below shows the current Drawdown for the Phi Plus Dax, Rayo Plus Dax, and Beta Dax V2 systems, as it compares to the pre-release Max DD, and the estimated stop trade/reevaluation levels (lines in the sand) as derived from each of our four methods discussed above, with the average of the four shown. As can be seen, the 1.5 times tested max DD is a relatively valid measure, as it quickly and easily gives an estimated future drawdown close to the more mathematically advanced methods. Investors can choose which method they wish to ascribe to, or use the average of the four to measure what point they should stop trading the system or reevaluate their trading.

Low risk, high reward "Trade" Opportunity

For those investors not currently trading the Phi Plus, Rayo Plus, or Beta V2 Day systems, the drawdown levels in each represent an excellent "trade" opportunity. This is an equity curve "trade" where you are buying the system at an extreme discount. The current level represents an option play of sorts that costs $4,900 in Phi Plus, $1,200 in Rayo Plus, and $7,300 in Beta V2 - with an unlimited upside. The system(s) are just 30 Euros per month, and using the Rayo Plus Dax system as an example, the downside risk is just $1,200 to the stop trade point; meaning you only have to risk $1,200 for the chance to make over $26,000 (if the system makes back the $11,000 drawdown plus earns the $15,000 average annual return it saw before the current drawdown). Making over $26,000 on a $1,200 investment represents a return over 2,000%.

- Jeff Eizenberg


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Feature | Week In Review: Stocks and Commodities Rally | Chart of the Week


Both the US Stock and Commodity markets enjoyed nice rallies last week. Stocks rallied for the same old reasons, as earnings continue to look . Despite your feelings on the current conditions of the stock market it has been hard to argue with the bulls as stocks continue to climb higher albeit very slowly. Stock futures enjoyed the run up last week, with SP 500 futures climbing +0.72%, NASDAQ futures were up +0.74%, Russell 2000 futures gaining +0.64%, and SP Midcap 400 futures rallying +0.99% higher.

Several commodity markets also enjoyed rallies last week, led by the meats which saw Lean Hogs gain +8.85% and Live Cattle climb 2.53% higher. Grains also continue to look with Corn futures rallying +6.31%, Soybeans up +4.64%, and Wheat up +0.70%. The tropical commodity markets also enjoyed up moves with Coffee gaining +5.83%, Cotton up +3.21%, and Sugar seeing an increase of +0.70%. Finally, Gold and Silver also rallied with Gold futures gaining +0.77% and Silver futures climbing +0.96%.

Notably absent from the list of rallying markets are the energies. Energy prices continue to fall despite threats of production cuts from OPEC. supplies have allowed prices to fall with Crude Oil futures losing -2.39% last week. Heating Oil futures were also down losing -0.93% and Natural Gas futures lost -1.61%. Surprisingly, Unleaded Gas futures did not follow suit with RBOB Gasoline futures gaining +2.67% last week.

Finally, trading in foreign currencies and US Treasuries picked up last week due to the FOMC announcement. The Fed decided to hold interests rates steady which caused US Bond futures to rally +1.10% and the US Dollar to fall -0.84%. Swiss Franc futures rallied +1.35% on the news while Eurocurrency futures were up +0.87%. Japanese Yen futures also gained ground on the US Dollar after climbing +0.79%.

***CTA Trading***

New to our weekly newsletter, we will be reporting on some of the Managed Futures programs (CTAs) we Attain, showing week to week activity and results. CTA investments, while transparent to the actual investor, are more obscure to the prospective investor in that results are reported monthly instead of on a daily basis and that actual trade by trade records are not readily available.

Despite the Dow hitting all time highs, the real action has been in the energies this month, and the Phoenix Energy program has been able to capitalize on the short term volatility of the Crude Oil, Natural Gas, Unleaded, and Heating Oil markets. With market ranges for the month in Heating Oil experiencing a 8.6% range and Crude Oil a 9.5% range there has been a lot of opportunity. Phoenix gained approximately 2% on a nice long trade in Unleaded last week, and is earning close to 5% in October on a nice bounce back from recent losses.

Elsewhere, the option selling CTA programs have generally not enjoyed the recent market run up, as the rally has caused volatility to diminish, with approximately 70+ days without at least a 1% pull back. The Argus program continues to fight its way out of what can be described as its worst case market environment - a quick, steady move higher, by rotating to further out positions and covering portions of losing positions when possible.

Elsewhere, Zephyr and Zenith were the exception, with their short Put positions declining close to worthless on the run up.

***Day & Swing Trading***

Several day trading programs have been patiently waiting for a sharp correction to the downside and have been quick to enter short looking for that breakout. While it didn’t pay dividends for most programs last week that tried to go short, the market appears to be setting itself up for some nice short trade opportunities in the near future.

Compass SP was the top performer last week by squeaking out gains of +$250 on two trades. BetaCon 4/1 ESX also had a small gain of +$71.08 on one trade from Friday.

The Dax programs were unprofitable last week after several whipsaw trades caused by the FOMC, etc… Phi Plus and Rayo Plus were the most affected with losses of -$1,803.73 and -$2,834.68 respectively. (see discussion above for more on the Dax system drawdowns)

Day trading programs may be looking for a correction in stocks, but swing systems would just as soon the market head to infinity and not look back. Stocks haven’t had as much as a hiccup recently - making for ideal conditions for swing systems. But the million dollar question as always is when to exit the trades. Last week several systems including Tzar ES, Tzar NQ, Spartan ES and Axiom eMD added to open trade equity by holding onto their long positions.

Outside of equities, bond and forex programs have also been trending as well. Mesa Notes took some heat early in the week but rallied back and was able to exit a long trade for -$253 but after making back about +$685 in open trade equity. Jaws Narrowneck Bonds profited +$712.50 on a short trade that it entered into the previous Thursday. Forex systems came into the week with a short bias but reversed long after the Fed announcement and have latched to some profitable trades thus far. SC Forex and Delphi EURUSD were holding long as of Friday’s close for open trade profits of +$2,590 and +1,185 respectively. If the up trend continues, both will be looking to reach their profit objectives early in the week.

***Long Term***

Most commodity sectors kept the same pattern of sideways action with high volatility during the past week. The tug-of-war between slowing economic growth and a fairly high rate of core inflation have kept market participants in a state of flux and put a halt to nice trending markets for the time being.

Price action in the rate sector last week was mostly higher after some late week economic reports showed signs of a slowing economy sparking renewed buying interest. The sector shows signs that an assault of recent 30+ month highs that where scored at the beginning of the month could come into play soon. Some systems with long positions are Andromeda +$2196.88 (open trade) and Vivaldi +$543.75 (open trade) in USZ. Aberration is long TUZ with open trade equity of -$187.50.

Most of the major currencies again posted upside gains during the past week as worries of a slowing U.S. economy sparked some pressure on the U.S. dollar, but the rally did nothing to threaten downtrends. Systems with short positions in SFZ and JYZ include Andromeda making +$96.500 per contract (open trade) and +$1943.75 per contract (open trade), Pegasus making +$800.00 per contract (open trade) and +$1118.75 per contract (open trade). Aberration is short SFZ with an open trade loss of -$1500.00 and Axiom LT is short SFZ making +$500.00 per contract (open trade).

The energy markets posted some gains last week backed by ideas that OPEC members would indeed follow the lead of Saudi Arabia and adhere to agreed daily production cuts, but the gains were not steep enough the get the market out of it’s 4+ week sideways channel. Systems with short Crude oil positions include Pegasus which is making $+14,390.00 per contract (open trade), Trend Simplicity which is making +$12,830.00 (open trade) and Aberration +$5500 in a mini.

Grains and Oilseeds continued to remain in their current trends, although wheat continued to work on a downside correction. Soybeans remained fixed in their rally as end-users continued their aggressive attempt to cover needs for protein demand into the winter months. Cotton did post a relief rally during the past few session, but prices seem to be capped by a downtrend on oversupply and a lack of export business. Systems with long corn positions include Aberration making +$2175.00 (open trade), Andromeda +$1500.00 (open trade), Axiom LT +$3125.00 (open trade), and Trend Simplicity +$1375.00 (open trade). Systems with short cotton positions are Andromeda +$460.00 (open trade), Axiom LT +$5520.00 (open trade), Trend Simplicity +$555.00 (open trade), and Vivaldi +$2610.00 (open trade).

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Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.

Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.

Please read carefully the CFTC required disclaimer regarding hypothetical results below.