Smoothing Equity Curve- Reducing Drawdown

This subject is by far the most important one in fund management. A lot of fund managers and traders alike fixate on trying to develop new ways to produce an equity curve that is as close to a 45 degree line as possible. I was once told by an experienced fund manager that “success in our business=smooth equity curve.” Thats where you will fund hot money following into your management. You can have the highest return, but if that comes with a drawdown thats really high (ie 50-80%), not many investors will invest in you.

Although my ultimate goal is to manage a hedge fund with quantitative strategies that pursues absolute return, i want to achieve absolute results with minimal drawdown/risk. There are different ways to do that. 

You can continue on to search for better entry techniques…and waste your time there. The other important and useful way is to apply proper money management. 

Money Management

Portfolio Heat: capping the % of open positions so that in case all positions go sour you will only loose x% of your portfolio

Sector Exposure: allocate a maximum % of your capital to each sector limiting highly correlated assets to increase your risk

Position Sizing: how much should you buy/sell whenever you receive a signal from your system

Volatility Control: high volatility may cause wide equity swings; finding a way to limit that will help in terms of lowering portfolio volatility

Portfolio Selection and Diversification: trading as many markets as possible and forming one portfolio where assets are least correlated will increase the odds of catching the trends and making up for the losses

The above are a few pointers i have come across that have shown value in reducing drawdowns.


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