In our private client area, we often talk about the importance of understanding drawdowns.
The first step in dealing with drawdowns is to acquire the right mindset that is conducive to trading.
Do you want to learn how to live through the daily drawdown that is almost inevitable and all traders must go through?
Statistics have shown that the majority of your life trading career will be spent in drawdowns.
If you spend so much time in a drawdown, it’s important to learn how to recover from drawdowns.
With that said, here are 3 trading tips you should use to help you recover from drawdowns:
#1 Know the Maximum Drawdown of Your Trading Strategy
Through effective backtesting methods, you can actually discover the maximum DD of your trading strategy.
This will mentally prepare you for them.
If a trader learns how to develop an awareness of what will happen to his account during a drawdown period, you’ll have the mental capacity to cope with the drawdown and stick with your trading strategy through these tough times.
That’s assuming you have a profitable strategy.
If you can’t learn to master this discipline, then you’re better off to stick to algorithmic trading and let the robot do the job for you.
Automation will often eliminate counterproductive emotional decisions.
#2 Cut Back Your Position Size
Another thing you can do to cope with the painful reality of drawdowns is to risk per trade or the position size. Contrary to the popular belief that teaches you to increase your risk, so you can accelerate the recovery process, that type of behavior is very destructive for your account balance.
Aggressive pyramiding to escape a drawdown is even worse.
Take for example, how legendary trader Richard Denis thought the Turtles to handle drawdowns.
When drawdowns occurred, they would reduce the trading size from 2% down to 1.6%. They would continue to cut back their position size if the DD was extending.
This preventive action is for self-preservation of your capital.
Learn it, and use it in your favor.
#3 Increase your Risk-Reward Ratio
A positive and big risk to reward ratio is part of every successful trading system.
To escape a drawdown faster you need to learn how to increase your risk and reward ratio.
One of the most effective methods to improve your RR ratio is to perfect your entry strategy.
By having a better market timing you can keep your stop-loss very tight, thus further limiting your losses.
With a RR ratio of 1:3, you can escape a drawdown period pretty fast even if your win rate is still somehow very low.
If you can make a pact with yourself and not flinch in the face of adversity when your risk tolerance is reached your daily mental battle is half won.
Final Words – Drawdown in Forex Trading
In summary, drawdown forex is the most important risk metric because DD can make you switch your trading strategy if you have too many consecutive losses or if our losses last for too long. Forex drawdown can literally kill your account if you don’t know how to recover from a drawdown trading period. The only way you’ll never experience a drawdown is if you stop trading. You need to accept the reality that the drawdown in forex trading is inevitable
There is no such thing as risk-free returns. You need to work smart not only to make profits but to also keep those profits. With that said, you only need to keep in mind these three drawdown trading rules, if you want to manage DD like a pro:
Know your historical max DD
Cut back your trading size
Increase your RR ratio
Thank you for reading!