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Strategy monitoring

The ongoing measurement of a live strategy against its expected behaviour, with thresholds decided before deployment for when to reduce size or stop.

Monitor the inputs as well as the outputs. Trade count versus expectation, average holding period, realised slippage versus modelled, hit rate, and the distribution of position sizes all shift before the equity curve does, which makes them earlier warnings.

Set the rules in writing while calm: if realised slippage exceeds the model by 50% for a month, halve size; if the rolling-sharpe over six months falls below zero, review; if the drawdown exceeds 1.5 times the worst in backtest, stop and investigate. The value of writing it down is that the decision is made by a person who is not currently losing money.

Distinguish monitoring from second-guessing. The purpose is to detect breakage, not to trade the equity-curve. A strategy inside its expected drawdown distribution is behaving correctly even when it is unpleasant.

Related: live-vs-backtest-divergence, kill-switch, rolling-sharpe, alpha-decay

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Slippage on a market orderA buy order clears four price levels, so the average price paid is worse than the price first quoted.Buy 1,000 shares at marketpricesell orders resting (bar length = size)20.04300 shares20.03200 shares20.01200 shares20.00300 sharesnothing resting at 20.02order sweeps up the bookaverage fill 20.02SLIPPAGE0.02 a share$20.00 in totalintended 20.00Each level fills at its own price; the average is what you really paid.
Slippage on a market order. You click at 20.00, but only 300 shares are resting there, so the rest of the order fills at 20.01, 20.03 and 20.04. The average price paid is 20.02, and that two-cent gap is slippage.
An equity curve and its drawdownAn account balance rising over a year, falling from a peak to a trough, then climbing back to the old peak.ACCOUNT EQUITY$20k$12k$8k024681012TIME (MONTHS)PEAK $16,000TROUGH $12,000DRAWDOWN−25%RECOVERY
Equity curve and drawdown. An account balance plotted month by month. The fall from the $16,000 peak to the $12,000 trough is a 25% drawdown, and the shaded area lasts until the balance climbs back to the old peak.

Educational only, not advice. Spotted an error? Post in Site Feedback.