There are several unpleasant things in trading that you can’t avoid. For example, drawdowns or slippage. Since you can’t get rid of them, you should learn how to cope with them. There are ways to reduce the size of drawdowns.
So What is Drawdown in Trading?
Drawdown shows how much the price of an asset has fallen relatively to the entry point. A drawdown does not mean a loss, as a loss is a realized trade, while a drawdown is temporary.
Determine Your Maximum Drawdown
Any trade must have thought-through entry and exit points. Make sure to set Take Profit and Stop Loss on each position. Your drawdown should not exceed the distance from the entry point to Stop Loss. Bear in mind that each transaction may also include a commission and slippage.
Unfortunately, it’s very difficult to estimate the real loss by distance on the chart. With a large trade size and high leverage, a movement against you by just a few points can result in a loss of tens or even hundreds of dollars.
To set the maximum drawdown, follow these steps:
- Determine the maximum loss size in dollars.
- Calculate the spread size in USD taking into account the transaction size. Subtract the spread and commission, if any, from the maximum drawdown.
- Calculate the distance on the chart for the remaining amount, according to your trade and leverage sizes.
- Set your Stop Loss at the resulting distance from the entry point.
Reducing the Drawdown Size
If you keep losing more than you want, try the following ways to reduce your drawdown:
- Set the maximum drawdown depending on your capital size. Risk no more than 1-2% of the investment for each trade and 5-6% for all open trades.
- Set maximum loss for the day, week, month. When you reach the set amount, give up trading before the end of the period.
- Reduce the size of your positions and/or trading leverage.
- Move your Stop Loss closer to your entry point. Install it immediately after opening your position.
- Use trailing-stop. Move your Stop Loss closer to your entry point and further if the price moves in the desired direction.
- Hedge your losing position on a correlated currency pair. For example, if you lose money selling USD/JPY, you can open a buy trade on USD/CHF.
- If you are still confident that the chart might reverse in the desired direction, you can partially close the position to reduce the overall drawdown.
- Diversify trades with non-correlated trading instruments.
One more little tip. In case of a gap, Stop Loss doesn’t guarantee that a trade will be closed at the right moment. Try to keep an eye on your positions.
If you can’t frequently look at the charts, you can install a special program that will send you a sound signal when the chart reaches a certain price. At this moment, you can check your position.
Stay Calm
Traders open way too many unfortunate trades out of revenge after a drawdown. Other traders lose confidence and start missing out on great trading opportunities out of fear.
To avoid such situations, try to accept that losses, and sometimes significant ones, are inevitable. You can’t get rid of them but you can control them. The methods from this article will help you out. Good luck!