Importance Of Risk Analysis.

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The significant indicators of risk analysis

In the framework of this course we cannot research too deep the appropriate material. We will only note that the risk analysis - it is independent area of science, that is based primarily on mathematics and statistics. Due to the research in this area it is possible to come to some conclusions about the results that may be expected from the system in future on actual basis (on basis of the information about results of transactions, i.e. of statement).

We will consider here (only with the aim of illustration) two important indicators:

MDD (Maximal Drawdown Down)
RF (Recovery Factor)

These two indicator in combination give us the image of system ability to return at the first level of balance after the transaction. Let us discuss it more profoundly.

Originally at the fund exchange market, where trading is led by sessions (for example, from 9 a.m. to 18 p.m. in accordance to a time zone), MIDD indicator was used (Maximal intra-day drawdown). Taking into consideration that in the end of the day all the transactions should be closed, this indicator could be interpreted as the maximal drawdown of the whole period of trading.

Look at the illustration.

Picture 18. Maximal growing drawdown

Here we can see that changes in balance was developed as follows. The stable deposit growth with relatively small drawdown took place before a-point, and this is of not our interest right now. the first significant drawdown appeared at a-point, that, however is not maximal growing drawdown, as later (after small recovery) the decrease of the balance level continued and b-point saw another local minimum. However b is not maximal drawdown. C-point saw absolute minimum of deposit of the whole history of the trading, and the distance from the "x" local minimum (blue line) is MDD indicator.

What should be reviewed with attention. Here we will not take the probability theory, however we should note that it is clear intuitively for any person. If there were several unprofitable transactions and that led to drawdown at "a"-point, then an analytic, that reviews this graphic should think of what will happened. for example, of this situation repeats. We have the second drawdown at "b"-point, that is remarkable of the fact that after the first drawdown the balance has not recovered yet. The third drawdown (at c-point) was less deep, however, it kook place until balance could recover to "x" point.

Here we came to the point where the second indicator should be introduces - Recovery factor. It is the correlation between the absolute profit (for the whole period) and maximal increasing loss, i.e.

this indicator reflects indirectly the system ability to recover after drawdown, and consequently its stability and efficiency. Most analytics agree that 1.6. recovery factor is a ground one. Under condition that the system has demonstrated the recovery factor more than 1.6, this system can be regarded as stable and effective one. If the recovery factor is less than 1.6. the loss of deposit is more probable, as the speed of recovery after draw-down can be not fast enough.

In conclusion to this chapter it should be noted that two reviewed factors can be used for the most general analysis of the given statement of system work. Nevertheless this method is quiet simple and effective. You can find more detailed information among books in The List of Recommended Literature.

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