The Upside of Drawdown
A normal part of online forex trading is drawdown. It’s not often talked about because it isn’t “sexy,” but drawdown isn’t something you need to be afraid of.
What’s Drawdown?
Drawdown is when your trading account equity moves down in value. Forex traders want their balance to go up, so periods of declining account equity are typically feared, but they shouldn’t be because drawdown is normal.
Eliminating drawdown completely would require you to accurately & consistently pick the HIGHEST price & LOWEST price in every trend. This is almost impossible due to variation in prices, known as volatility in financial markets. Nobody on earth can accurately get the highest price & lowest price on each trend. We can get good prices, but there’s always a better price we could have got.
Close Enough for Profits
As a forex trader you can correctly guess the trend direction. If prices are likely to go up, you buy. If they are likely to go down, you sell. But once you buy/sell to open a position, it doesn’t mean prices will turn around the moment you place your order. Moments after you open your trade, a better price is often available. When this better price is available, you are experiencing DRAWDOWN…
This is ok.
Sometimes better prices are available DAYS after you opened your position, resulting in a larger drawdown. You don’t want to panic, because you still may be correct about prices going up over the longer term. You can also benefit from periods of drawdown.
Larger Profits with Drawdown?
A period of Drawdown is a windup for better profits.
Let’s look at a trade where we buy (long) 1,000 units of EUR/USD @ 1.3100. Prices expected to rise to 1.3300. Wait to 1.3300 to sell.
Look at these 3 scenarios:
Scenario #1 – No DRAWDOWN: If prices go from 1.3100 straight up to 1.3300, we make 200 pips on this trade. This is the ideal case as we won’t experience any drawdown.
Scenario #2 – Moderate Drawdown: If prices go from 1.3100 down to 1.3000, we are at 100 pips of DRAWDOWN. This is a point where some traders get nervous, start feeling sick and start to doubt what they’re doing. But there’s also an opportunity. We could buy another 1,000 units @ 1.3000. This brings our average open price to 1.3050. Now, when the price rises to 1.3300 we make 500 pips profit! This is 250 pips per 1,000 units traded.
Scenario #3 – Severs Drawdown: If prices go from 1.3100 down to 1.2900, we are at 200 pips of DRAWDOWN. This would tempt many traders to panic, but it’s also an opportunity to increase profits. If we buy another 1,000 units @ 1.2900, we make 600 pips profit when we reach our target at 1.3300. This is 300 pips profit per 1,000 units traded!
As you can see, larger drawdown gives potential for higher profits. The key is not to confuse drawdown with trend reversal. As long as you still believe you are right about trend direction, drawdown is really just a difference in timing between you & the market…a difference that can earn you higher profits.
Avoid Drawdown Denial
There are times when you should cut your losses and prevent drawdown from wiping you out. There is a point where drawdown turns into devastation. It’s a line you need to walk carefully. It’s not something to fear, it’s something you need to understand how it fits within your trading system.
With portfolio hedging, drawdown is automatically accounted for & used to grab higher profits when the drawdown turns into a huge UPSWING! To receive the benefits of a well planned money management system that uses drawdown as an advantage (and avoids drawdown as much as possible), check out the rapid forex hedge report today.
Tags: drawdown, hedge report, online forex trading, opportunity, portfolio hedging, volatility Posted in
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January 31st, 2012 at 12:14 pm
Brian,
Thank you for this great piece on how drawdowns are just sometimes part of doing business. Most of us know that when we put on a position, we are automatically in a drawdown due to the spread alone.
These past couple of weeks, I know I am experiencing something that I have never experience before. I know for a fact that a year ago, I would of closed out many of these trades in drawdown and probably went looking for another system to learn. I know I have never experience this kind of drawdown ever. If I did not have such a great teacher and mentor, I may have just closed out all my trades or went on to another strategy. But, I am so confident in this system, I am embracing drawdowns as my friend in forex because in the long run it will produce better results
I know during this period of drawdown, we can certainly learn a lot about ourselves and I have greatly. I am thankful for having such a great forex mentor and coach to assist us during these times. I realize that money is not made over night, but over time.
I know it takes time and our mentor is showing us the way to financial freedom.
Thank you for your time and energy in teaching us how to be profitable traders.
Lets go make some pips!
Rob
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Rapid Forex
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February 1st, 2012 at 10:05 am
@Rob – You bring up some good points. My Grandfather used to say “If you look for something wrong, you’ll find it.” Trading takes discipline & dedication. If someone wants to prove that they can’t trade successfully, they’ll quit during a drawdown period (or even after their first bad trade) and then they’ll say “I was right, that didn’t work.” If you read Dan’s comment, it took him 10 years to figure things out. It does take time…but it also takes time to become a Doctor, Lawyer, or any valuable profession. The money that’s traded in forex becomes fuzzier. The value isn’t as fixed as we’re used to. This requires a different mindset. We’re living in a probability dimension that seems different than the world we live in. We actually live in that world, but it happens on a slower scale. It’s money, and it is serious. But like Dan said, it’s also a game. One of the requirements is not to trade more than you can afford to lose. Weathering the storm is essential to catching the big waves. It is an interesting psychological experience, and it’s funny how quick attitudes can change
I’m enjoying it all!
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January 31st, 2012 at 2:19 pm
How strange that this note was to come to me today of all days, recently I decided that my tiny forex account although making tiny profits each month was merely a game – I have been involved with the forex since 2002 and was an original Rapid forex trader. since that time I have done trading on a 1000 dollar account and each time it reaches 300 above I would remove it from my account and it would become income to spend or save or whatever – it was fun but useless as a business – my original education was with your “rapid forex courses” (which I still have by the way) and with Rob Booker and of course with both “Rapid forex” and FXCM (my broker today from the first day I started by the way) – I have always been a bit afraid of too much drawdown and therefore would be exeptionaly conservative hence small or tiny profits, recently I decided to allow for a more substantial drawdown based on my research and belief that a market would go up or down. I started doing something I heard of once that the Japanese Traders called “bending into the wind”, this means being more accepting of drawdown when my research is pointing in my direction of choice, and guess what it worked!! I have been ten times more profitable on average -wow – what a wake up that was!! this simple trading choice and opening of my trading style, has helped me beautifully to become the trader I always knew I was finally -so when I read your new article I felt it was time to tell you, the one who started me in this business in the first place, I have always been a fan of yours and now I am also a firm believer in my self as a forex trader – thank you sir keep up the amazing work for the beginning or inexperienced trader they need it and as you can see it sometimes takes 10 years to wake up finally (look at me)
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Rapid Forex
Reply:
February 1st, 2012 at 9:57 am
@Dan – Thank you for sharing that. Sometimes it takes 10 years of dedication to get there. When you won’t accept failure, it doesn’t matter because the only inevitable outcome is success. I’m glad you hung in there.
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January 31st, 2012 at 3:56 pm
I’d like to learn more about how to make the decision to cut losses to prevent wipe out. How to make that determination. And what to do to take action on it.
What may be obvious to some is not necessarily so for others.
I closed some positions to apparently bring me back to a safer level from margin call only to find the drawdown continue back to closeto perilous values near more closures due to margin call again.
Any teaching about when to cut losses short or other ideas to manage th balance would be appreciated if possible.
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Rapid Forex
Reply:
February 1st, 2012 at 10:09 am
@Larry – This depends on the trading system. In portfolio hedging, losses are automatically cut by the HR algorithm. With other methods stops are used to cut losses. This is half of the art of trading, the other half is when to take profits. Forex Sailing deals with this in terms of retracements or reversals. Sometimes what you think is a retracement (don’t cut the loss yet), turns into a reversal. When the trend obviously turns, you need to cut losses. Sometimes the trend is still good, so you don’t want to panic and sell. This post wasn’t really a strategy, it was illustrating a principle – showing that drawdown is not only necessary, it’s also a good thing.
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February 2nd, 2012 at 1:54 pm
I quitted too early on the drawdown on 28th December 2012 when gold price fell from 1713/ozt to 1592/ozt. If I continued holding the position,I wouldn’t have experienced great loss because now the price of gold has rebounced to 1755/ozt. Thank for your good advice Brian.
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March 1st, 2012 at 1:07 am
Hallo Brian,
This info about the drawdown is probably the most usefull info I learned this year, provided I guessed the trend correctly.Panick stations were the normal reaction.
But I still suffer from the ‘hind sight is perfect sight syndrome’
If I watch the charts, normally about 4 hours a day, I am spot-on 4 out of 5
The moment I put in a trade, its wrong.
Any advice will be greatly appreciated
Many regards Johan
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