Trading the Equity Curve Through Drawdowns

Summary

The document asks whether reducing exposure in a leveraged long/short equity portfolio at predefined drawdown thresholds can manage risk, and what risks such active deleveraging may introduce. The proposed approach cuts portfolio exposure in stages as losses deepen. The response identifies this practice as trading the equity curve, a broader label for adjusting exposure based on the strategy’s performance history.

The cited discussion points to a practitioner blog that evaluates the idea using random data and notes an interest in academic research. However, the document provides no results from that analysis, no formal academic references, and no evidence that the suggested thresholds improve outcomes. It therefore offers terminology and a direction for further investigation rather than a tested rule. Any assessment would need to account for how exposure changes affect returns, recovery after losses, and the risk of reacting to noisy fluctuations in the equity curve.

Key ideas

• Adjusting exposure after portfolio losses is commonly described as trading the equity curve.
• The proposed method reduces a leveraged portfolio in stages as drawdown thresholds are crossed.
• Exposure changes based on past performance can alter both losses and subsequent recovery.
• The document identifies a practitioner discussion but supplies no empirical conclusions or academic evidence.

Tags

# Leverage and Drawdown


# Leverage and Drawdown












What are the risks of deleveraging a leveraged long/short equity portfolio when going into a drawdown at certain drawdown stops, like deleveraging by 30% when breaching a -5% drawdown, deleveraging a further 30% when breaching a -10% drawdown?

Is active de/releveraging in and of itself considered to be a risk management tool and are there any academic treatises available on this?

## Answer by Hans-Peter Schrei (score 2, accepted)

https://quant.stackexchange.com/a/36484

By chance I became aware that this is generally known as "trading the equity curve". More information can be found at this blog [1] of a former AHL researcher. He is also looking for more information on academic treatises.

[1] https://qoppac.blogspot.co.uk/2015/11/random-data-evaluating-trading-equity.html

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.