Thursday, April 7, 2011

One Way To Choose A Forex Signal Provider - Let's Examine Draw Downs

By Tom K Kearns

To begin, let us define the term Draw Down. A draw down is the total amount lost between an extreme high and an extreme low and is the very first thing a person seeking a third party signal provider should pay close attention to. The draw down amount encompasses open positions without taking into account the margin required to prevent a margin call. The burning question becomes then how much draw down is too much draw down? Like many questions asked of the trading business, the answer is - it depends. This is not a cut and dried circumstance; many factors abound in the answer to this question. A person with an account of many thousands of dollars can obviously tolerate more draw down than a person with less, but what else is entailed in the answer?

You have the draw down number. How was that number derived? If the draw down number seems intolerable to you but other factors make the trader a good bet, examine the number of positions the trader opens at a single time. Say he opens 5 trades on whatever pair at one time, right away you can cut their recorded draw down by 5. If a trader's number of open trades is limited, that alone severely reduces the entire draw down figure.

You will on occasion discover a trader with a fine track record with the exception of one large meltdown suffered when just one trade ran amok for days unnoticed. This will give a distorted picture due to the abnormal draw down and doesn't mean much in relation to the trader's true ability. You may have stumbled on the type who can't tell when or if a trade has a shot at coming back to an even status. Or, the poor chap could possibly have the lousy luck of losing his connection to the internet at some very bad times. To keep this sort of thing from happening to you, set your own stops with the trader. Do make sure though that the stops you put on his trades are only those that are well out of reasonable trading range.

At this point, we are going to visit again our original question. Now that you have accomplished all you can to limit draw down, I will caution you by saying any amount over 35% of your total account equity is way overdoing it. If you let yourself become in a situation where a 50% plus loss is incurred, coming back from it would involve some extremely risky behavior. A 50% loss demands a 100% gain just to get back on the level.

Historical information on the trader is another important consideration to take into account. A lengthy history being available can illustrate to you just how the trader handles rough seas in the trading arena. You want to know this because there will be rough seas in your trading future and you want a steady captain at the helm.

Do not just let go once you have selected your trader. You must constantly monitor his activity on both live and demo accounts. Should his draw down get crazy, it is undoubtedly time to reappraise your situation with him and perhaps delete him from your portfolio completely.

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