Examining Draw Downs When Selecting A Forex Signal Provider
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?
Besides the size of the draw down number are the events that formulated it. A trader with a draw down of a size so high it makes you nervous but otherwise seems a successful one, you need to take a look at the number of positions he has open at one time. If he opens 5 trades on whatever pair at one time; you can immediately reduce his record of draw downs by 5. The trader who limits the number of open trades can sizably cut down the overall draw down.
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.
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.
You must constantly monitor your traders on all of your accounts, whether live or demo. Should any draw down run rampant, you will need to reevaluate and possibly delete the trader from your active portfolio.
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