Financial Risk Management For Dummies

Chapter 12

Controlling Drawdowns

In This Chapter

Distinguishing drawdown control from stop-loss policies

Calibrating drawdowns

Thinking about your investors

Implementing a drawdown control system

Moving forward after a drawdown

There are two main ways losses are defined in finance – losses from an initial investment and loss in a position relative to its peak value, known as drawdown. Both types of loss are painful, of course, and both can be fatal if not controlled.

Perhaps surprisingly, risk management is entirely different for losses from initial investment, for which you should use stop losses (covered in Chapter 11) and drawdowns, for which you use drawdown control as described in this chapter. One of the most common and dangerous risk management errors is to use a stop-loss technique to control a drawdown – or a drawdown control technique to stop a loss.

Comparing Stopping Loss and Controlling Drawdown

Drawdown is the decline in an investment from its highest value. Drawdown ...