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Withdrawal Rules for Balancing Trading Risk and Compounding

Article Quant Q&A · Author: Gazillionaire
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Summary

The document poses a risk management question: how to choose a withdrawal fraction and a profit threshold for taking money out of a trading account while balancing ruin risk against compounding. It gives an illustrative proposal based on withdrawing part of profits when a drawdown condition is reached, and suggests relating the withdrawal rate to the Calmar ratio, which compares return with maximum drawdown.

No derivation or answer establishes an optimal rule. The stated return and drawdown figures are the questioner's estimates, not validated performance evidence, and the example does not specify a return distribution, withdrawal timing, capital needs, or what “ruin” means quantitatively. A defensible rule would require modeling uncertainty, serial dependence, changing returns, and the effect of withdrawals on capital at risk. The document is therefore useful as a framing of the tradeoff, but it does not provide enough information to compute a reliable withdrawal percentage or threshold.

Key ideas

  • Withdrawal rules trade off reducing exposed capital against preserving account growth through compounding.
  • The question proposes using profits and drawdown conditions to trigger withdrawals.
  • The Calmar ratio is suggested as a possible reference for a withdrawal rate, without a derivation.
  • An optimal rule cannot be determined from average returns and maximum drawdown alone.
  • A ruin-risk analysis needs assumptions about return uncertainty, withdrawal timing, and capital needs.

Tags

Risk managementPosition sizingPortfolio construction
Full text
# Optimal withdrawal rate based on alpha and drawdown


# Optimal withdrawal rate based on alpha and drawdown












My trading returns is about 50% monthly(alpha) and maximum drawdown is about 20%. Is there a mathematical way to define the optimal withdrawal rate X%(say when profit level reach y%) to avoid risk of 50% ruin? i.e. how to find X% & y% for the best balance between risk vs compounding rate? For e.g, withdrawing 50% of monthly profits if quarterly max drawdown is 25% and compound the rest of the profits... simplified Withdrawal rate =the inverse of calmar ratio.

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