A normal part of online Forex trading is drawdown. It’s not often talked about because it isn’t “sexy,” but drawdown isn’t something you need to be afraid of.
What’s Drawdown in Forex Trading?
Drawdown is when your trading account equity moves down in value. Forex traders want their balance to go up, so periods of declining account equity are typically feared, but they shouldn’t be because drawdown is normal.
Eliminating drawdown completely would require you to accurately & consistently pick the HIGHEST price & LOWEST price in every trend. This is almost impossible due to variation in prices, known as volatility in financial markets. Nobody on earth can accurately get the highest price & lowest price on each trend. We can get good prices, but there’s always a better price we could have got.
Close Enough for Profits
As a Forex trader you can correctly guess the trend direction.
If prices are likely to go up, you buy. If they are likely to go down, you sell. But once you buy/sell to open a position, it doesn’t mean prices will turn around the moment you place your order. Moments after you open your trade, a better price is often available. When this better price is available, you are experiencing DRAWDOWN…
This is OK.
Sometimes better prices are available DAYS after you opened your position, resulting in a larger drawdown. You don’t want to panic, because you still may be correct about prices going up over the longer term. You can also benefit from periods of drawdown.
Larger Profits with Drawdown in Forex Trading?
A period of Drawdown is a windup for better profits.
Let’s look at a trade where we buy (long) 1,000 units of EUR/USD at 1.3100.
Prices expected to rise to 1.3300. Wait to 1.3300 to sell.
Look at these 3 scenarios:
- Scenario #1 – No DRAWDOWN – If prices go from 1.3100 straight up to 1.3300, we make 200 pips on this trade. This is the ideal case as we won’t experience any drawdown.
- Scenario #2 – Moderate Drawdown – If prices go from 1.3100 down to 1.3000, we are at 100 pips of DRAWDOWN. This is a point where some traders get nervous, start feeling sick and start to doubt what they’re doing. But there’s also an opportunity. We could buy another 1,000 units at 1.3000. This brings our average open price to 1.3050. Now, when the price rises to 1.3300 we make 500 pips profit! This is 250 pips per 1,000 units traded.
- Scenario #3 – Severs Drawdown – If prices go from 1.3100 down to 1.2900, we are at 200 pips of DRAWDOWN. This would tempt many traders to panic, but it’s also an opportunity to increase profits. If we buy another 1,000 units @ 1.2900, we make 600 pips profit when we reach our target at 1.3300. This is 300 pips profit per 1,000 units traded!
As you can see, larger drawdown gives potential for higher profits.
The key is not to confuse drawdown with trend reversal. As long as you still believe you are right about trend direction, drawdown is really just a difference in timing between you & the market…
Avoid Drawdown Denial
There are times when you should cut your losses and prevent drawdown from wiping you out. There is a point where drawdown turns into devastation. It’s a line you need to walk carefully. It’s not something to fear, it’s something you need to understand how it fits within your trading system.
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