The volatility over the last couple of weeks in the markets has led to a number of trades being closed at a loss, as well as some open profits in existing positions being eroded. This is all part and parcel of trend following, particularly when there is a change in the overall market trend. The question then arises about whether these open profits should be taken into account when looking at drawdowns.
As I mentioned on here previously, while the current performance summary on the sidebar includes open profits, I am far more concerned with cash equity. When calculating position size, I do not take into account any open profits or losses - purely the cash held.
Trend following only works by cutting losses and letting profits run. This means that, in time terms, losing trades are cut quickly (in my own case, within a day or so), and profits are left to run as long as the trend remains intact (I recently closed this position which had been open for more than 3 months).
Due to the own way I cut losing positions, it is only really possible for my performance inclusive of open positions to be worse than cash equity held at worst for one day. I want my positions to be in profit from the start, otherwise they are not performing as anticipated.
Therefore, to me, I consider tracking cash equity a far more relevant metric to keep an eye on - I recently posted my own cash equity curve here.
Jez Liberty runs the excellent Automated Trading System blog, which tracks the performance of a bunch of standard trend following systems, as well the majority of the well-known CTA's utilising trend following principles. He posted this interesting piece on the question of open profits and drawdowns.
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