Drawdown in MTS trading

Every trading methodology has a point where if there are x consecutive loses, the account will either be wiped out or the drawdown will be so large that the return required to recover would be unpalatable (50% drawdown requiring 100% return, for instance - although this is largely personal). As Hanover points out, the length of this potential sequence is purely a function of position risk.

Regardless, no amount of money management can prevent this unlucky series of trades; it can only decrease the probability of its occurrence. However, if one has a comprehensive understanding of their strategy - including statistical data based on a large enough sample size - it doesn't need to feel like this fearful quest to maximize profits before the impending catastrophe. For example, lets say you have a trading system, with thousands of trades worth of data, where based on Monte carlo simulations you find a 99% confidence level of not exceeding a 25% drawdown. Could you exceed 25% drawdown at any given time? Sure. Assuming that you trade your system over an infinite period of time it will almost certainly fail completely, but what is the 'likely' time frame for such a failure? Within 5 years, 10 years, 100 years? The probability, and thus the length, of a sequence necessary to destroy one's account is completely under the trader's control. At certain position sizing levels, the likelihood of it occurring within a trader's lifetime can be extremely small - at such small levels, the chance of your edge deteriorating (or your system's ability to adaptively capture it) becomes a much more likely culprit for eventual failure than that unlucky sequence...

The bottom line is that we can never deal in certainty. Anything can always happen, and things can suddenly change in unforeseen ways. This is the case with most things in life that, unlike casinos, aren't confined to static probabilities. The casino could theoretically fail if that extremely low probability (in the casino's case) losing streak was to occur; as traders, we could fail either as a result of:

1) a functioning edge but detrimental losing streak
2) no edge/diminishing edge.

What matters is that you are aware of this, and know what you would do in any potential situation. You would know that when you reach a certain drawdown level you are outside of expectation and should either stop trading completely or cut risk significantly while you continue to at least paper trade the strategy to see if it does ultimately recover. If it does, then you can resume trading; if not, thnn at least you only lost x% of your account, and hopefully achieved significant net profit regardless. Use position sizing to trade a system that has drawdown expectations that are tolerable for you; then, even if you exceed them in that catastrophic event - be it an unlucky sequence or a failed/non-existent edge - you haven't lost something that you weren't prepared to lose.

Personally, I tend to be more conservative, and like to have the probability of even a 15% drawdown be very low, but this is obviously just my comfort zone. I find it fascinating how different traders approach this question. I remember a certain fairly prominent trader on this forum who allegedly ran up an account 1000% in a year, risking - if I remember correctly - 8% on each trade. He was so immodestly certain that, based on testing, his system would continue to work - even though during testing it had some incredible drawdowns. I didn't even doubt the quality of his testing, but his certitude was ridiculous, especially after the live year. At 8% risk, you don't need THAT many losing trades to destroy you. Of course, it all crashed and burned, and his future posts were somewhat more humble.

I think that is really what Tdion is getting at: that sense of certainty that many seem to have, and how it is completely unfounded. I get that and I agree. At the same time, the hysteria surrounding luck in trading is overdone. Know what to expect as an acceptable worst-case, the likelihood of it happening, and what to do if it does happen within your trading career.