One of the least significant statistics of any manager or trading system is its returns. Returns alone tell investors nothing about the risk required to reach those returns. For example, how do we know if a 100% return is good or bad? The answer should be “it depends on the risk required to get it.” Does anyone care if a few managers or systems earned a 100% return If an even greater percentage of the investors lost all their money first?
What does matter is RISK-ADJUSTED RETURNS. Only when we know how large of a risk a system or manager took to reach a return can we properly evaluate the performance.
So how can we measure risk-adjusted performance? One of my favorite ways is using the MAR Ratio. MAR is short for the “Managed Account Reports Ratio.” What MAR measures are the average yearly percentage return divided by the largest percentage drawdown. It is important investors use percentages and not raw profit or loss dollar amounts for the ratio to be correct.
If for example, a manager or trading system had an average yearly return of 30% and at one time experienced a maximum drawdown of 15% then his MAR Ratio would be 2. In others words, 30 divided by 15 = 2.
What is an excellent MAR Ratio? To determine this, I think one of the best places to look is in the world of professionally managed money. These managers are often the best of the best when it comes to traders. In some cases, they have track records 20 and 30 years old and have hundreds of millions or even billions of dollars under management. When we look at the best of those managers, they are LUCKY if they can maintain a MAR Ratio of 1! Meaning, if they have made an average of 30% a year, then they also likely endured a onetime largest drawdown of 30%.
I hope this sets off a few alarms in your head. Traders should wonder how it is they see products offering off the chart performance when the best of the best cannot do it. They may experience a “lucky” period, but 99.9 percent of the time they took more risk than a trader would probably ever want to.
This article is about realism, and what I think is truly possible with top caliber trading systems and money managers. Keep in mind, I have developed trading systems for over 18 years and have won many awards for them. Besides this, I have gone on to be a successful hedge fund manager attracting tens of millions of dollars in investment capital.
So, what do I think is possible? The answer is a MAR Ratio of about 1.5 – 2.00. In other words, an average yearly percentage return about 1.5 to 2 times higher than the maximum percentage drawdown.
By: Dean Hoffman
FUTURES TRADING IS NOT SUITABLE FOR EVERYONE AND PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF SUBSTANTIAL LOSS IN FUTURES TRADING OR WITH ANY TRADING SYSTEM OR PROGRAM. CAREFUL EVALUATION OF YOUR PERSONAL FINANCIAL SITUATION MUST BE DONE PRIOR TO DECIDING TO TRADE IN THE FUTURES MARKETS OR ANY GIVEN TRADING SYSTEM OR METHODOLOGY.