Thursday, December 18, 2014

Leverage – The Bringer of Destruction. Risk vs Return.

I recently saw this chart of “Max Drawdown % Risk” verses “Return %”, of a large number of traders on the SaxoBank website.


Firstly and obviously, zero risk is zero return.  Returns rise from this point until the number of 50% return-makers flatlines from 8% - 30% max drawdown risk, (lower horizontal green line).  It then seems to start to fall along the top of the cluster above the red trend.

As risk increases, the red trend is far more significant to the downside in an almost linear relationship.  Over 80% max drawdown risk seems to imply a return approaching 100% loss.

If you look at the overall cluster running along the top of the red line, it seems safe to say, that increasing risk does not constitute increasing returns for most traders.

The top performers (who must take some risk to generate a return) sit in the 40-55% max drawdown risk range.

No-one with 75% max drawdown risk or more has doubled their money.

The greatest cluster of 100% return-makers, sits somewhere around the 20-30% max drawdown risk range, (upper horizontal green line). This seems to be a reasonable place to be when you include the possible returns below it as well.

Importantly, these are just subjective eyeball observations, and the traders here are most likely using a variety of strategies, and are of varying skill/experience.  A bigger sample size would also be great to have, (820 on the website).

Humans have a great awareness of risk through survival instincts, but this does not seem to translate into the markets!

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