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system
how to calculate average drawdown of a trading system?
user
first of all, i think i'll clear off some confusion in the topic. the sterling ratio is a very simple investment portfolio measurement that fits nicely to the topic of personal finance, although not so much to a foreign exchange trading system. the sterling ratio is mainly used in the context of hedge funds to measure its risk-reward ratio for long term investments. to do so, it has been adapted to the following in order to appear more like the sharpe ratio:  i suppose this is why you question the average largest draw-down. i'll come back to that later. it's original definition, suggested by the company deane sterling jones, is a little different and perhaps the one you should use if you want to measure your trading system's long term risk-reward ratio, which is as followed:  note: average annual draw-down has to be negative on the above-mentioned formula. this one is very simple to calculate and the one to use if you want to measure any portfolio's long-term results, such an example of a 5 or 10 years period and calculate the average of each years largest drawdown. to answer @dheer's comment, this specific measurement can also be used in personal investments portfolio, which is considered a topic related to personal finance. back to the first one, which answers your question. it's used in most cases in investment strategies, such as hedging, not trading systems. by hedging i mean that in these cases long term investments are made in anti-correlated securities to obtain a diversified portfolio with a very stable growth. this one is calculated normally annually because you rely on the annual risk-free rate. having that in mind i think you can guess that the average largest drawdown is the average between the largest/maximum drawdown from each security in the portfolio. and this doesn't make sense in a trading system. example: if you have invested in 5 different securities where we calculated the largest draw-down for each, such as represented in the following array: maxdd[5] = { 0.12, 0.23, 0.06, 0.36, 0.09 }, in this case your average largest draw-down is the average(maxdd) that equals 0.172 or 17,2% if your portfolio's annual return is 15% and the risk-free rate is 10%, your sterling ratio sr = (0.15 - 0.10)/0.172, which result to 0.29. the higher the rate better is the risk-reward ratio of your portfolio. i suggest in your case to only use the original sterling ratio to calculate your long-term risk-reward, in any other case i suggest looking at the sharpe and sortino ratios instead.
assistant