Underwater Equity Curve
There is a chart I have perused many times during the process of learning algorithmic trading. Unfortunately, I never gave it the respect I should have. It is called the Underwater Equity Curve.
Here is a definition of the chart, “The Underwater Equity curve, popularized by Jack Schwager, presents a trader with a unique way of evaluating equity performance. Using this graph, the trader can view the relationship between time and magnitude of drawdowns as they relate to new equity highs.
“This graph enables the trader to look at the performance from a pessimistic viewpoint. It pinpoints how much drawdown occurred and how long it took to rebound to hit a new equity high.”
A traditional equity curve plots the closing equity value, or account balance, for a trading system bar-by-bar in relation to time. The underwater equity curve focuses on losses bar-by-bar in relation to time. Now you can inspect all the drawdowns through a visual chart of drops in equity.
This chart makes it possible to distinguish between normal and extended periods of losses. The underwater equity curve sort of graphs the pain and suffering experienced by traders who follow a methodology.
Most traders will look at the profit chart only, and some will actually acknowledge the MDD and MDD duration, but what I’m learning is that is only part of the story.
Amibroker created this Underwater Equity Curve.
From this chart, you can see the Maximum Drawdown (MDD) was -29%. An MDD of -29% would’ve been enough to make me walk away.
Let’s look at this a little closer
As you can see from the chart, this drawdown took place in August 2011 the month the US debt was downgraded by Standard and Poors. But up until August 2011, the MDD had only been a little over 16% and within my parameters of an acceptable drawdown. Since August 2011, the MDD was under -15%.
Here’s another Underwater Equity Curve.
This system had an MDD of -54% back in March 2009. On the other hand, if you look at the drawdown in 1988, you’ll see it lasted years.
Do you see the difference between the two charts? Do you see why an underwater equity chart like the first one is what you should be looking for?
I don’t think understanding the UnderWater Equity curve will help you live through drawdowns. But it will certainly help you evaluate systems. And the better you are at evaluating systems the more you’ll come to realize just how good the QiT algorithms are.
Although we do not post the Underwater Equity Chart for each portfolio, I will provide them on demand.
ALWAYS FOLLOW THE RULES
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