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5 Secrets to Avoid Drawdown

Posted by BluFX

 

secrets to avoid drawdown

Nobody likes to feel like they’re losing, right? When the equity in your trading account goes below the amount of your initial investment, this is called drawdown. Drawdown periods might be short or a few days long, but either way, we know it can be panic-inducing.


Some strategies - like good exits, or varying your timeframe - tend to help you avoid drawdown. Here are a few of them...

Struggling to get out of drawdown? Here’s how to trade profitably on a BluFX account>>

Read: How to Trade Profitably On a BluFX Account ⟶


How to Avoid Drawdown

1. Develop an exit strategy for each trade

A common mistake that new traders make is letting their losses get out of hand. There are three basic strategies for exiting a trade once you have made it. 

  • The first is to take some profit at the target price, which means the price at which you bought/sold on your way into the market. This is what many new traders are taught - buy low, sell high.
  • The second is to exit when your original stop loss is triggered, preventing you from incurring more potential trade loss. 
  • The third exit strategy is trailing stops, which place a stop loss trigger after the initial stop loss.

If your trade is plunging, put a stop loss order on it, so you don't lose all of your money if it drops further. You can set a fixed price or use an automatic system that automatically liquidates any position that drops more than a set threshold.

Using stops will protect your capital. The index may be trending up or down, but it doesn't matter if you are not using stops. Always set your stop to 1% above the point where you bought. It is virtually impossible to identify the end of a trend without setting stops because the market trades in cycles, meaning that it will frequently repeat behavior that led to movement in the past.

Most people do not have advanced technical knowledge of the market and tend to be reactive instead of proactive. Reactive investors take their stops out when they are wrong, which leads them to constantly fighting against the trend because they are always behind.

Want more exit strategy tips? Read 4 Essential Risk Management Tips...

2. Do not hold on to losing trades longer than necessary

If you buy currency and the price goes up, you're happy. If it doesn't, you're disappointed. And you're also probably more long-term oriented than most people, wanting to hold onto a position in hopes that it will turn around.

That's all well and good, but it can be dangerous to hold on too long to a trade that has taken a severe hit in investing. In fact, the longer you wait, the more likely it is that you'll force yourself into a situation where you have to sell the security at a significant loss.

Here are three things you need to do after making a loss>>

3. Find high probability setups that have a good chance of success

Most traders look for forex trading setups that last at least 30-40 pips. That is a solid strategy and a great profit target. However, good trades, setups that last over 100 pips, are the holy grail of forex trading.

If you can find a setup with a high probability of success, let's say 80% chance of success, it will make your account grow exponentially because you will be putting less money into trades that have a very high probability of working out.

By learning how to analyze a chart, you can start your filter process with any time frame and still get the best setups. However, keep in mind that longer-term charts provide more signals with a higher profitability ratio.

Here are the 12 types of technical analysis you should know about>>

4. Spread your trades out over a variety of markets and timeframes

Avoid discrepancy between your trading and your investments by diversifying the types of trades that you take. Many traders feel compelled to trade specific assets or timeframes, but no matter your tactics, if they are all close in length, asset type, and market, then they are correlated.

The goal is to spread your trades out over a variety of markets and timeframes. Some trades might be long duration, some short duration, and others medium. Some might benefit from trends and gaps, while others might need a price to stay range-bound to provide good opportunities.

Even during the most prolonged of bear markets, you can make money day trading. You can spread out trades over various markets and time frames to create strategies that are uncorrelated with the market's overall trend.

When it comes to drawdown, should you leverage your own money or use BluFX? We take a look here>>

5. Match the position sizing to your risk tolerance

The average trader is likely to use position sizing that is too large for them. For traders, trading too large a position size can lead to the inability to close out positions, forcing traders to keep risking more just to stay in the game.

Let's be honest. Few traders can handle drawdowns of 40% or more. Additionally, most forex brokers won't even allow such a drawdown level. If a trader has a risk tolerance that allows for a 40% drawdown, then great, go ahead and trade as large as the trader wants. But if the trader's risk tolerance is only 2%, then why make things harder on yourself by trading at a size that will create a 40% drawdown.

Be cautious and trade smaller than you'd like, as drawdowns can be brutal. The more aggressive your position sizing is, the more drawdowns you will see. Trade small and keep your losses small. If you can't handle losing 10%, find a strategy with lower drawdown and trade only a tiny fraction of the size and leverage you usually could.

Consider drawdowns to be a cost of doing business, and take advantage of them by trading smaller than you typically would. Don't dismiss strategies with large drawdowns entirely; they may provide value in terms of correlation and diversity. Ensure that you trade a variety of markets and time intervals.

Did you know that 72% of forex traders are relatively new to trading? Read 10 Forex Trading Stats You Might Not Know>>

Read: How I Got Started Trading for a Bank ⟶

Tags: Trading Tips

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