Risk. This is the first and most important metric for a systems trader to track and improve. When learning about a system or strategy, most people first ask about the returns.

Imagine you had one program that generated 21% per year on average and second was doing 35%. For some, the analysis is over because they just want higher returns. But what if that second program had draw downs of 12% and the first had draw downs of just 3%?

At the beginning, when your account is small, the focus is on generating returns. In the real world, traders want to add size. This can be accomplished by reinvesting profits, raising money, or working with a prop firm like SMB Capital to get leverage. But if the draw downs are large on a percentage basis, then it will be much harder to add size or leverage.

Taking our two examples: The first program with modest returns and a very low draw down could be leveraged 4x to reach the same drawn down level as the more volatile strategy but with more than double the total return.

This is why Risk is the first item we look at on the Seven Steps to Systems Success. It is the key to adding size and leverage to our number two focus—Returns—which is what we’ll talk about next time.

Andrew Falde

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