Managing Drawdowns in MM
Working at a major MM platform, wondering how PMs here think about managing drawdowns and also how risk managers at respective platforms treat drawdowns.
In my experience, I've found that even though max drawdowns are quoted at $X, I've typically gotten a call from risk asking for details when my current drawdown is 0.4-0.5 * $X, which I find a little absurd. Is this typical across all major platforms?
Also wondering how people size their books relative to max drawdown $X. For example, I typically size my annual volatility ($Y) at around $X / 1.3 - 1.4. My goal is to (hopefully) never/ rarely exceed half of my drawdown limit so I tend to cut around $0.5 * $X / 0.7 * $Y. Anyone out there more aggressive in using drawdown? How has that tended to work out with risk/ management?
The numbers you mention sound reasonable to me.
As for getting the call from risk, I think much of the point is for you to know "they're watching". I imagine after a few instances of seeing that you do actually manage drawdowns, they will leave you alone. But there's plenty of reckless guys out there that double down on losers until the day they get fired. Risk just wants to make sure you don't operate that way.
Your method sounds very reasonable and I am a similar thinking to yourself. That said I do not think the calls from risk is nesscarily bad always, while annoying its a part of the job and their job. Flying under the radar is great, if you plan to grow your book organically over time.
But I have seen the situation where you maybe spend 1 year and show proof of strategy/concept then maybe 1in5 career opportunity shows and you really want to push harder. Those people who have already shown to risk they are disciplined and stick to their strategy get more powder in those situations.
how do you guys think about managing drawdowns at a position level vs an aggerate book level? when you reduce are you focusing on outsized losers to cut or do you trim a bit across the book, or something in between?
Typically try to reduce clatter and find levels I would add to the positions I really believe in. Not so much is it a loser or not. More around was it a bad entry, is catalyst delayed, is the thesis still right.
In my experience if position reduction is forced by risk/firm they will demand reduction across the broad and usually whatever is easiest. This is why OP, is using a shorter leash on themselves is my guess. Nothing is worse than not being able to add risk (change risk is different) and just having to sit and defend your book all day.
Sorry if this is a basic question but what do you mean by "I tend to cut around $0.5 * $X / 0.7 * $Y." in the comment above ? (i understand the rest of the post, but dont understand this point). Thanks
I'm confused as to how you get to your annualized vol number. Vol = $X/1.4. Let's say you have a 20mm draw, does that mean you size to an annualized vol of 14mm/900k daily PL vol? Sharpe wise at a 2 you return ~30mm $PL, which is a bit low for a PM with a 20mm draw.
I'd imagine target for a typical PM with that type of draw is more like 50-80 depending on the seat. How do you think about meeting budget etc. on that risk? In practice it obviously is more pathwise but curious your thoughts.
You're saying that with a $20m drawdown limit you are targeting $50-80m of PnL? At a 2 Sharpe? So you're targeting running $30-40m of vol?
You should simulate a bunch of 2 Sharpe normally distributed return streams and see how long it would take you to hit your $20m drawdown limit running $40m annual volatility... you'd be out of a job very quickly
No. You're saying that you're running 14mm annualized vol while having a 20mm draw according to your description above (using hypothetical numbers). If you are a 2 sharpe trader, being kind to you as most discretionary traders end up below that amount, you're expecting 28mm of annualized PL. I'm saying that most platforms will not hand you a 20 million dollar draw if your claim is that you're expecting to make 28mm in a year.
I agree with your math that sampling using 30/40mm vol you'll stop out very frequently and am not pushing back on that. In practice I've found that PMs run low vol and try to make a bit of PL buffer early in the year/early in their tenures before pushing volatility as their distance from $0 increases as there's a lot more leeway/less career risk to going through a draw. Funds would view 60 -> 40 very differently from 5>-15. And as you draw you cut risk regardless.
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