A Look at Forex
Draw Down
     
 
How Much Draw Down Is
Too Much?
When you're looking for a third party signal provider,
one of the first things that you need to look at is
their maximum draw down. This is the maximum
amount lost between an extreme peak and an extreme
valley. This number also includes open positions
but does not take into account margin required to keep
you out of a margin call. Inevitably the question
comes: How much draw down is too much? The
answer is like many trading questions. It
depends. There are a lot of factors that come into
play when answering this question. Obviously a
person with a 50k account could tolerate more draw down
than a person with a 5k account. Another person
with a 1k account could withstand even less. So
aside from your account size, what else do we have to
think about?
Another thing to look at aside from the actual number is
how that number came to be. If a trader has a draw
down that is too high for you to tolerate but otherwise
seems to trade well, you should look at how many
positions he opens at a time. If that trader opens
5 trades on any given pair at a time you can instantly
cut their historical draw down by 5. Limiting the #
of open trades for a trader could drastically reduce the
overall draw down.
Sometimes you will find a trader who has a great track
record aside from one major meltdown where a single trade
ran out of control for days unchecked. This will
produce an abnormal draw down in relation to the traders
real ability. He may be the kind of guy who can't
recognize when a trade has no chance of coming back to
even. He may also be a guy who lost his internet
connection at an inopportune time once or twice.
Either way you can keep this trader from doing this to
your account by setting your own stops for him.
Just make sure that you only stop out his trades that are
well out of a realistic trading range.
Now that we're half way down the page lets revisit our
original question. After doing anything and
everything you can to limit draw down, I would say
that anything over 35% of your entire account equity is
just too much. Once you start to get into a
situation where you are losing 50% or more it is very
tough to ever recover without taking extreme risks.
If you lose 50% you need to make 100% just to get back to
even.
When considering draw down you should also look at how
much history is available on that trader. If he
only has 3 weeks of history than chances are that his
largest draw down is yet to come. If he has 50 or
100 weeks of history he has probably already hit some
rough patches and you can get a better idea of how rough
the rough patches are for that particular
trader.
Also remember to constantly monitor your traders on both
a live and demo account. If their drawdown gets out
of hand it may be time to reevaluate.
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