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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.

 

Posted in Money Management

Reward vs Risk for Forex Trading EXPLAINED

Lately I’ve been answering alot of questions about reward/risk ratios, it’s also part of the money management strategy taught in Forex Sailing.

Today I’m going to go a little deeper into this topic because it’ll help you understand online forex trading better.

Reward/Risk Ratio

Any time you place a trade, you should set a stop & limit. If you take the pips you will GAIN (if the trade goes well) and DIVIDE by the pips you can LOSE (if the trade fails), you get the REWARD/RISK Ratio.

This ratio gives you a percentage so you can understand the risk of the trade in a standard way.

Breakeven Analysis

Once you know the Reward/Risk Ratio, you can determine what percentage of the time you need to be correct to breakeven. If you’re right more than that you’ll make money. If you’re wrong more than that, you’ll lose money.

Let’s look at an example:

You find a Forex Sail. You determine that if you place a 100 pip stop and a 170 pip limit, you’ve got you’re trade. If you DIVIDE your potential REWARD by the total RISK you get 170/100 = 170%.

If we did many trades, here’s how we could breakeven:

1. Lose 100 pips 170 times = 17,000 pip loss
2. Gain 170 pips 100 times = 17,000 pip gain
3. Loss = Gain = Breakeven!

In this example there were actually 270 trades. We broke even when we were profitable on 100 of them. If we divide 100/270 (WINNING # of Trades / Total Trades) we get the BREAKEVEN PERCENTAGE.

In this case 100/270 = 37.04% is the BREAKEVEN PERCENTAGE

More About the Breakeven Percentage

If our trade works out more often than the BREAKEVEN PERCENTAGE we’re profitable as traders. In the example above we need to be right more than 37.04% of the time with that Reward/Risk Ratio…

Sounds good, doesn’t sound too hard to be right a little more than 1/3 of the time, right?

There is kind of a catch…a tradeoff really…

Breakeven Percentage Catch-22

The lower the breakeven percentage, the MORE LIKELY you are to be unsuccessful with your trade!

In our example the stop is much closer than the limit. Think about that for a minute…

If your stop is closer than your limit, you’re more likely to get stopped out, right?

The opposite is true. If the limit is closer than your stop, you’re more likely to hit the limit first.

Breakeven Percentage Chart

I’ve created a chart below with a few examples so you can see the pattern of Reward/Risk Ratios & Breakeven Percentages.

When reward = risk, you only need to be right half the time (50%) to breakeven (beige). This is common sense.

If reward < risk, you have to be right more often (light blue).

If reward > risk, you can be wrong more often (purple).

What Does This Mean?

In my next blog post I’ll be sharing more of what this means for making online forex trading decisions. For now, just think about the Reward/Risk ratio, and don’t make a trade without knowing what it is!

Posted in Technical Analysis

126 Pip Pivot Point Profit

Pivot Points are an incredibly useful online forex trading technique. A recent trade of mine yielded a 126 pip profit in only 50 hours, which grew my entire trading account by 10.04%, which is exceptional for 20-30 minutes worth of work!

Why Forex Pivot Points?

Pivot Points are one of the most commonly used methods of online forex trading. The pivot point takes the High, Low, & Close prices from yesterday and generates Support & Resistance target prices.

Forex Pivot Points are uncannily accurate when combined with the right directional entry strategy. In the example below you’ll notice the predictive nature of forex pivot points for online forex trading success.

Spotting Trend Direction

In the Forex Sailing course I explain the fibonacci wave theory for determining trend direction. In a recent post, I also explained EMA/MACD divergence for signaling key trend movements.

While the trade below could have been an excellent Sail, it also would have required a stop of several hundred pips, which would have violated the money management system followed by the LIVE Forex Training class.

For this reason, I used pivot points to capture a shorter term profit of 126 pips in 2 days. Here’s how the trade unfolded.

EUR/USD Daily Trend Moves Down

From Forex Sailing we had a forex umbrella handle form after breaking a longer uptrend on the daily chart for the EUR/USD. I’ve labeled the fibonacci wave with the key points of I, II, II on the daily chart below:

In the chart shot above notice how there is good separation of the EMAs and how the MACD is increasingly negative as prices make new lows. This is a strong signal that prices will continue moving down for several days. We also moved past II, which means we should move to a lower low to reach IV.

To confirm this direction I also looked at smaller timeframes, which lined up nicely as well to indicate downward movement. As indicated on this 4 hour chart below:

In this chart we also had nice EMA separation, and an increasingly negative MACD. While there was a fair amount of divergence, the trend direction was still downward. But a large enough stop was needed to make sure the divergence didn’t retrace too much before the trend continued.

The 15 min chart below also indicated a downward moving trend:

As newer lows were made we maintained a widening of the EMA, we also maintained strong negative MACD divergence as new lows were made.

Downtrend Confirmed -> Let’s Trade

With a downtrend confirmed on these timeframes, it was time to look at our pivot points for good stop/limit prices. For the entry price I used a price close to the pivot and found a EMA/MACD divergence on a 5 min chart.

Initially I set the following trade parameters:

Entry: 1.3397 short

Stop: 1.3547

Limit: 1.3274

This gave us a good reward/risk ratio of 82%. We were below the pivot price of 1.3453, so the stop was less likely to be hit than our limit. This initial trade would have netted 123 pips profit.

24 Hour Adjustment

The next day the pivot points were recalculated because the trade was still in progress.

Entry: 1.3397 short

Stop: 1.3411

Limit: 1.3271

This reduced our risk to only 14 pips, and increased our profit 3 pips from 123 to 126 pips. The next day the trade was exited for a profit. Here’s the picture of what happened during the life of this trade on the hourly chart:

You can see the entry price of 1.3397 (red line). You can see the price at which the limit was hit 50 hours later at 1.3271 (blue line). The stop isn’t included on this chart because that price was never approached

As you can see the price consolidated a bit, but moved downward overall. We managed to get in near the top of this price movement and captured a 126 pip profit in only 50 hours.

Posted in Technical Analysis