“(Benefits of Back-testing are glaringly obvious). Besides the advantage already mentioned, the back-testing provides a trader with more precise hints on how his strategy functions in different market phases, the described form of back-testing offers another substantial advantage that must not be underestimated: Given a thorough analysis of the strategy, the back-testing results give the trader the self-confidence necessary to cope with several loss trades in a row without losing confidence in the strategy.” — Faik Giese (brackets mine)


Mr. Chuck Fulkerson says that ego drives a trader to be right, but one must realize that the only thing that will always be right is the market itself. Earlier, his coach had told him: ‘‘Stop trying to be a specialist, and just be a good trader first.” Think of any trading concept or technique or method; I can guarantee that it’s doomed without effective risk management and money management. Think of any trading concept or technique or method whatsoever on this planet; I can guarantee that it’ll have losing streaks and winning streaks alternatively. A trading strategy won’t tell you it’s going to experience a kind of streak. In fact, the trade you think will be a winner because you’ve made the best trading decision in the world may still be a loser while the one you don’t enter because you think it won’t win may still be a winner. If a market is ranging, a trend trading strategy will be worthless. If a market is trending, a range trading strategy will suffer. The markets won’t tell you how they’ll behave next and that’s why you must always take safety precautions while trading.

There’s nothing in this world that isn’t temporary. When you’re in a winning period, it’s temporary. When you’re facing a losing period, it’s temporary. Now if you liked to bet 3% of your equity on a trade and you suffered 5 losses in a row (let’s say not on equity ratio, but on equal parts, for the sake of simplicity), you’d have 15% drawdown during the unsavory streak. It’d then be harder to break even during an encouraging streak. If you liked to bet only 1% of your equity per trade (with the type of aforementioned parts), you’d have only 5% drawdown during 5 losses in a row. The bigger the drawdown, the more difficult it will be to recover during a winning period. The smaller the drawdown, the easier it’ll be for you to recover during a winning period. It’s just that winners in a row won’t last long before losers in a row shove in, and vice versa. If there’s been a big drawdown, there wouldn’t be any breakeven in a situation of a row of winners before another row of losers.

A) Cutting winners prematurely would make the trader get frustrated over time. If you were in the habit of cutting your winners and running your losers, your running account might look like this:

Deposit: $100,000

Balance: 110,250

Equity: $81,220

This means that if all open positions were closed, your drawdown would be around %19, thus rendering the profits you previously closed meaningless. Is this what you want?

B). If you were in the habit of cutting your losses and running your profits, your running account might look like this:

Deposit: $100,000

Balance: $90,020

Equity: $$119,502

This means that if all open positions were closed, your account would grow by around 19%, thus rendering the losses you closed ineffectual. Wouldn’t you prefer this?

The Problem With Consistency

Last week wasn’t favorable to our system, but we minimized our losses. We’re even more determined to be tougher on Mr. Risk. We’ll give him no much chance at all! We want to be sure that only 3% – 4% drawdown is our worst-case scenario in a week (since this will make it easier to move far ahead when the markets are favorable to us). We need to be very much conservative and highly risk-averse. How can we be tougher on Mr. Risk? The answer would be given in our trading update on Wednesday.

I could call a passer-by who knows nothing about Forex trading and ask him to click a Buy or Sell button. He might do that and make some money if the market moves easily in his favor (and if he losses, I’d also tell him he’s lucky). You see, anyone can make money on any given day, but to be CONSISTENT, that’s the hardest part – to cut your losers quickly, to let our winners ride, to not get trapped in bad positions, and to trade only if you if you have great reasons.

I conclude with this quote from Joe Ross, a man with over 5 decades of trading experience; one of the most experienced and the most respected traders in the world:

“Trading is not a job. If you want a job, go out and find one. Trading is to be done leisurely, with plenty of time in-between during which you do not trade at all. You cannot possibly be at your best all of the time while sitting and watching a screen. The pros typically trade a short period of the day, usually around the open, and then again at the close. That’s why they last as long as they do. For those who stay in the market because they act as market makers, they trade their own money only when they can take advantage of you for a few ticks at various times during the day. Otherwise, they stand aside, waiting to fill orders from the outside, which is what they feel they have to do.”

Your questions and opinions are highly welcome.

Thank you.

With best regards,

Azeez Mustapha

Forex Signals Strategist, Funds Manager &Coach

Email: amustapha@fxinstructor.com

NB: There is risk of loss in trading, but it is possible to be a successful trader.

Newly Created

©2010 FX Instructor Forex Blog - For Traders, By Traders. All Rights Reserved.