it down when it comes to how one must go about examining the markets and the
systems in an appropriate and scientific fashion. One of these analysts is John
Sweeney, who, in his two books Campaign Trading(Wiley Finance Editions,
1996) and Maximum Adverse Excursion(Wiley Trader’s Advantage Series, 1997)
came up with the concepts of maximum adverse excursion(MAE) and maximum
favorable excursion(MFE). More recently, RINA systems has taken this further
and developed a method to calculate the efficiency of a trade. I, too, have written
several articles on closely related topics for both Futuresmagazine and Active
Tradermagazine.
Depending on what type of entry technique you use, many of your trades will
experience an STD before they start going your way. This is especially true for
short-term top and bottom picking systems, where you enter with a limit order. In
this case, the only way to avoid an STD is to enter at the absolute low or absolute
high—and how often will that happen?
Longer-term breakout systems also many times experience both an STD and
an ETD when they enter and exit with a stop order on the highest high or lowest
low over the lookback period. Usually, the entry level coincides with a pivotal
resistance or support level in the market. After this level has been tested and
you’ve entered the trade, the market usually makes yet another correction before
the final penetration, and follow-through takes us away in a major trending move.
At the exit, most long-term systems give back a substantial part of the open prof-
it before the exit is triggered by a breakout in the opposite direction.
(To learn more about the different types of drawdowns and the maximum
excursion analysis for stop placements, see Trading Systems That Work. We will
talk more about stops and exits in Part 3 of this book, but will focus on techniques
and analysis methods different from those in Trading Systems That Work.)CHAPTER 5 Drawdown and Losses 65