#Common Causes of Drawdowns in Forex Trading

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Drawdown in Forex Trading with FTG

The blog titled "Drawdown in Forex Trading – Understanding and Managing Losses" delves into the concept of drawdown in forex trading, which refers to the decline in a trading account's equity from its peak due to a series of losing trades. The guide emphasizes the importance of effectively managing drawdowns to preserve capital, maintain confidence, and avoid impulsive decisions during challenging market phases. The blog explains the different types of drawdowns, including equity drawdown and maximum drawdown, and provides a simple formula for calculating drawdown percentages. It discusses common causes of drawdowns in forex trading, such as market volatility, unsuitable strategies, overleveraging, poor risk management, and external factors. The psychological impact of drawdowns on traders is highlighted, emphasizing the emotional toll they can take, leading to self-doubt and anxiety. The long-term effects of drawdowns on trading performance are explored, including capital erosion and missed opportunities. Strategies for managing drawdowns are extensively covered, including risk management techniques such as proper position sizing and setting stop-loss orders. Diversification and asset allocation, utilizing trailing stops, revisiting and adjusting trading strategies, and the importance of analyzing historical data are also discussed. The blog emphasizes the psychological aspects of dealing with drawdowns, including maintaining discipline, overcoming fear and greed, and the importance of keeping a trading journal for self-reflection and growth. The conclusion underscores that drawdowns are a natural part of forex trading and can be opportunities for growth rather than failures. It encourages continuous learning, adaptation, and using the support and resources provided by Funded Traders Global to navigate the challenges and successes of forex trading.

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How to trade Forex?

Out of idle curiosity, they do not come to Forex, anyone who enters here pursues one single goal – to earn money. This wave is possible, Forex trading can bring a stable income. Each trader uses different trading strategies, methods and approaches for this purpose. So, having a common goal, traders go to it in different ways. Choosing your path is the most difficult task for a novice trader.

First steps on Forex How often do novice traders fail to understand how to trade Forex correctly? "Proper" trading involves a wide range of different aspects. The most important ones, for example, include:

1. the Desire to learn how to work on Forex

Very often, the eagerness to open positions ends when the novice "drains" his first Deposit. If his desire to become a trader is strong enough, after losing, he will find the means and strength to "get back in line". Of course, he must analyze his loss and take into account all the mistakes he made. 2. Psychological training of a traderThe psychological factor in trading is of particular importance. Patience, self-control, and the ability to control your own emotions and not succumb to the "herd" reflex inherent in the market "plankton" are factors that help a trader keep any situation under control. 3. The ability to learnA trader may be eager to understand the theory of market trading, but if he has problems understanding simple school subjects, it will be difficult for him. He can easily start trading Forex, but the result of his trading may be questionable.

4. The tendency to analysisRegardless of the results of trading, it is necessary to constantly analyze every working day, every transaction made. This is important for identifying patterns that help / hinder the trading process.

5. Make informed decisionsNo one will decide for the trader which lot he should enter the market, when it is possible to open/close a position. No one will tell him to use a particular trading technique, where and when to apply a particular trading approach. Undoubtedly, in the course of training on some courses such as "Forex for beginners", as recommendations, he will be given tips by a coach/teacher. But this stage will soon be completed and the newly minted trader will be one-on-one with the market. He will have to make all trading decisions independently.

6. The availability of seed capitalThe opinion that it makes sense to start on Forex only on a large Deposit is wrong. There are examples when a trader went up when starting to trade on a cent account, the trading rules are the same for any deposits. It does not matter what size the initial capital will be, it is important how the trader will dispose of it.Of course, a large Deposit will allow you to exit a large lot and withdraw a large profit. But in the case of drawdown, the loss will also not be small. According to the "risk / profit" ratio, both a small and a large Deposit are equal to each other and are exposed to the same risk. The difference between them is only the lot size.

7. Free timeWe have already mentioned that you can trade on the Forex market using different approaches and methods. In any case, each of them requires that the trader devote a certain part of his time to Forex. When manual scalping, for example, the trader must always be at the monitor. It is important for him to track the market situation and the slightest price fluctuations in order to open/close positions on time.Profit by scalping per trade on average is 2-5 points. Imagine how much time a trader needs to spend to collect their daily profit? Sometimes the number of transactions per day is measured in the hundreds. However, today you can trade using special trading robots-day and night "scalpers", but even their work must be periodically monitored.In addition to all the above, the trader needs to have a workplace and appropriate equipment – a computer or laptop, as well as access to the Internet with high data transfer speeds. A weak Internet connection can cause a loss of connection with the broker and cause a loss on a transaction that is not closed in time.Novice traders often do not understand the very principle of making a profit on Forex. It is important to understand the nature of its formation in order to obtain a stable income in the future.Where does the profit come from? The mechanism of speculation on the stock exchange is simple – "buy cheaper", and "sell more expensive" or Vice versa. Remember, Forex trading is about making a profit from the difference between "buy/sell" or "sell/buy" prices. This is a real currency speculation-a commodity that on the currency exchange some are ready to sell/buy, and the second are ready to buy/sell. Let's look at the simplest example of trading "on the rebound" from the support/resistance line:In the figure above, there is a Support level 1 and a Resistance level 1. Next, you can see how the price breaks through the Support level 1 and goes further down, and the Support level 1 becomes the Resistance level 2, because at the retest, the price cannot break it and bounces off it, going down. Further it is seen that a short pulse movements price still fails to break Resistance level 2, then she rushes up Resistance 2 again turns into a Support level 1.Here you can open a buy position, both on the price breakdown and on its rebound from the Resistance level 2. After the breakout, the price rushes to the Resistance level 1, so the closing of the purchase transaction occurs when the price reverses from this level. When you close a " buy " deal, you can immediately open a sell deal. Now, let's see how successful Forex trading was, and calculate the profit on the purchase:Opening price = 1.15695Closing price = 1.16025Difference (1.16025 – 1.15695) = 330 (points)This "difference" of 330 points is the trader's "profit" on this trade.Now we will convert these points to the currency ( $ ) and find out what profit in monetary terms the trader received:Let's say that he entered a lot equal to $0.1 and earned $1 on each point, then his profit was $330. A lot equal to $ 0.5 would bring him a profit – 330 points x $5 = $1650. If he entered a lot equal to $1, at each point he would take 10 times more, i.e., he would earn 330 points x $10 = $3330. It is clear that the amount of profit depends on the size of the lot – more lot, more profit and Vice versa, less lot – less profit. Remember that Forex trading is not only a way to make a profit, but also a risk of making a loss. A big mistake for a beginner will be to enter the market with a large lot with a small Deposit. If the price suddenly turns around and goes in the opposite direction when the position is open, the loss can be the same 330 points. Now, calculate for yourself what lot the trader had to enter the market and what volume his Deposit had to be in order to withstand a pullback of 330 points?Competent traders do not allow such situations, they close unsuccessful deals in time so as not to waste time and nerves waiting for a miracle. It is better to lose a little in order to be able to open several new successful deals and cover a small loss with the profit received on them. Beginners who do not know how to trade on the Forex market usually "hang" on such transactions and long languish in anticipation of when the market will turn around to face them. Some of them open opposite trades in a panic, simultaneously increasing the volume of the lot, and again observe the sad picture – the market has turned around again, but not so much that it was possible to close the first trade with a profit. Now there are two deals "hanging" in the market and both are in a good minus.Ignorance of the market, its functioning principles, trading rules, basic greed for their own money and panic-these are the main enemies of a novice trader. Remember, Forex for beginners can be harsh and even cruel, but its lessons are very effective and give a significant practical experience. It is not necessary to treat trading as the main way of earning money from the first days of trading. You will still have time to quit your old job, this will not happen before your income on the stock exchange becomes stable and regular. Where can I learn to trade on the Forex market? A beginner usually learns about Forex by accident and immediately strives to "go learn to be a trader". The wording is incorrect, because only regular practice will make a trader out of it. At courses or schools of training in Forex trading, they will learn to understand the specifics of the market and the principles of its functioning. There they will also learn about the basic rules of trading, learn how to analyze the market and use trading tools. All these are the basics of market trading, on the basis of which a novice player must develop their own trading tactics and strategy.It is not so difficult to start trading on Forex as to hold on to it and, if not to increase, at least not to "lose" your capital as much as possible. There are two ways for a person who wants to become a trader:

1. Take a special training course at the trading school.As many believe, this is the easiest and fastest way to become a trader. It should be noted at once that not every school and not every course of study is equally useful. Most often, this service is paid, and it is difficult to say how effective the training process will be, especially for a person who does not understand anything about the specifics of the issue.During the course, the teacher will do everything to make you feel like a "seasoned" trader. Very often, such courses are a bait to attract a novice to trade, forcing him to take a Bank loan to open a real account. Usually, the first Deposit is "drained" by a newly minted trader in a few days, and the obligations to the Bank remain... Be careful.Positive aspects:Choosing the form of training (paid/free, full-time/distance). Guaranteed acquisition of a certain knowledge base for a specified period of training.

The control of the acquired knowledge by the teacher is a stimulating factor for learning. Negative side:Financial expenses (if the paid form of training is selected). The influence of the teacher's subjective opinion as the primary source of the information received on the novice's worldview. If his opinion is not quite correct or erroneous, it will be difficult to get rid of it in the future. This is due to the fact that everything said by the teacher, the student is always inclined to perceive as the immutable truth. The effectiveness and quality of training depends on the competence of the teacher. A very nice offer from the teacher to open a real account with a fairly large Deposit in his company.

2. Learn Forex trading on your own.This method is considered complex, difficult, and time-consuming. But, remember the popular saying "Live forever-learn forever" or the aphorism "there Is no limit to perfection". That's right, Forex for beginners and experienced traders will always throw up riddles, which should be solved throughout the entire trading practice.There is a lot of printed and electronic material for self-learning today. In whatever form you choose the "source of knowledge", you will definitely acquire the necessary basic knowledge about how to trade Forex correctly. It is also important to understand that without a reliable and effective trading strategy, it will be difficult for you to succeed in trading.Positive side:Free learning method. Training at a convenient time. The ability to draw conclusions independently, based on information obtained from different sources. Negative side:Processing a very large amount of information that is difficult to understand at once. The process of understanding "what's what" will be faster if you start trading Forex using a demo account in parallel with the training. The absence of a person nearby who can prompt or" on the fingers " explain some nuance that hinders further progress in training. But even in this case, there is a way out – contact the Internet. On specialized forums today, you can find the answer to any question. It follows that both methods of learning are acceptable, and everyone has the right to choose the method that seems easier and more accessible to them. Against the background of many differences between them, they also have a common feature – neither in the first nor in the second case, no one will give you a good trading strategy. A real trader should develop it independently, taking into account the experience of other traders, using their own trial and error.Training is an important stage of learning the Forex market for beginners, without which they will not be able to become a trader. It is better to learn the basic concepts yourself. You should go to the courses if you need help in learning trading methods and strategies.For example, the vehicle "Sniper X" has already been tested in practice by a huge number of traders and has proven its effectiveness. This non-indicator trading system brings stable profits, no matter how well you know the Forex market. Forex Academy offers you a free basic training course on "Sniper X", so that you can start today and every next day, consistently get your profit.Where to start, what to strive for? Before you decide that it's time to start trading Forex for real, on a real account, you will have to go through several difficult stages. Let's write them down as a simple sequential algorithm. So, you will have to:Learn the basics of trading in order to correctly understand the events taking place in the Forex market. Practice for some time on the demo account, excluding the possibility of receiving a loss of real financial funds. Find a trading strategy that best suits your character, temperament, and trading method. Determining the risk level for your Deposit and for each transaction, studying the rules and principles of money management. The study of methods of analysis of the market. Familiarity with technical tools (indicators, oscillators, Gann lines, Fibonacci lines, etc.). Improve yourself and work on improving your trading strategy. For beginners, the question of finding a reliable and profitable trading strategy is particularly acute. That's right, because there is no universal recipe for where to get it. To shed some light on this topic, let's look at the existing types of trading systems:Indicator vehicles Even in the simplest version, they can bring a good profit. They are a combination of several indicators and have clear trading rules. They contain specific instructions on when and under what circumstances you can open/close trading positions. For beginners, Forex trading usually begins with the use of such vehicles. Sometimes, due to changes in the market, such systems need to be upgraded. This circumstance can be considered their only drawback.Graphical method Today, this method of trading is considered the most reliable and profitable, so you can start trading on Forex using it even on a demo account. Initially, the difficulty is only the lack of skill to see certain graphic designs on the chart, but this comes with experience.Unlike indicator systems, the graphical method does not require upgrading, since it is based on trading "by levels". The principle of building "resistance/support" levels is always the same, regardless of what is happening in the market.In addition to levels, this method considers various patterns and graphical shapes on the chart. Their formation tells the trader about the continuation of the trend or the beginning of its reversal trend. The difficulty here is that the trader can not always correctly recognize them.Trade " on the news» News trading refers to high-risk methods and can be used as a backup vehicle. In the Forex market, trading on news is not safe for novice players. News – as the only reliable source can not be considered. Before making a decision "on the news", check their reliability, study their impact on the market with the help of other vehicles.Candlestick patterns It so happened that the method of trading on candle patterns – certain combinations of Japanese candles, is not very popular among traders, despite its high efficiency. Although Forex trading on the TS "Price Action" patterns has become widespread, it does not have many adherents. Working with Price Action patterns involves using them simultaneously with other graphical analysis tools. These include trend lines and horizontal levels more often. This method requires the trader to have certain skills in recognizing patterns on the chart. This skill comes with experience as a result of daily practice.As you can see, it is quite easy to start trading on Forex, it is more difficult to trade for profit, rather than at a loss. This requires willpower, patience, a desire to learn, and the ability to take every trade seriously, and to make important trading decisions in a balanced and reasonable manner.If you do not want to risk a large Deposit, start trading on a cent account, so as not to stay long on virtual trading. Try to "grow" your capital and don't be afraid to use new vehicles that were previously "tested" on the demo account or in the strategy tester.Don't forget that the demo account is very useful as a training simulator. However, with it, you will never experience the same emotions and responsibility as in trading on a real account, even if it is a cent. As practice shows, Forex for beginners is a kind of "Pandora's box", which is fraught with a mystery. How dangerous it will be for the trader depends only on him and on his efforts in training. There is an opinion that Forex trading requires some specific mathematical and economic knowledge. This is an incorrect judgment, because in the history of trading there have been and are today very successful traders with a liberal arts education. In a number of successful "gurus", there are traders without any higher education at all. If you are an expert in Economics or higher mathematics – this is your bonus and only. You will find a use for it, so you will strengthen your position on Forex and increase the percentage of profitability on your transactions.A serious problem for traders is the repetition of the same type of mistakes. After completing the training and making the decision to start trading on Forex, the trader does not cope with his psychological state. When opening a deal in one direction, he can hardly survive price fluctuations, begins to panic and makes serious mistakes. Analyzing the history of his trading, he understands the reason for these mistakes, but he repeats them again and again, unable to cope with his own emotions.Summarize The mechanism of trading on the Forex market can not be called complex, its entire algorithm is reduced to pressing one of two buttons in the terminal – "Buy"/"Sell" ("Buy"/"Sell"). The difficulty arises at the stage of analyzing the chart and price fluctuations to make a decision about opening a trading position. As a rule, to analyze the market situation, a trader uses the same methods and tools to search for entry points/exit from the market-others. The trader's path to success is thorny and difficult, but if it is passed, success will be provided for him.

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Common Knowledge is a Trading Trap.

Traders cannot really predict the market.

Any trader will tell you that behind every good strategy, lies at least a tiny amount of logic. This base claim seems somewhat obvious because why would a trader assess the market according to what seems to be a reasonable strategy, but a yet unstable one too.  

As traders, we are dedicated to proving the logic of our strategies over and over again. However, this logic will not always work out the way it was intended. There are many factors that may divert the course of logic due to the unpredictable nature of the market. If you’ve been in the industry long enough, you will know that no strategy is 100% loss proof. At the end of the day, it is a probability game, where risk management should be added for protection from the time that the trading strategy fails on its logic.

If your strategy sometimes fails, why would you try to predict the market rather than act on what the market shows you? Acting on the market, rather than the predictions is a more sensible way to decode the secrets of the market.

Acting on the Market

There are many reasons why logic may fail and I believe that there may be no logic to the market. A trading market is a chaotic place where different motivations gather at the same arena with their specific motives.

Sometimes it happens during peak and demanding hours and sometimes even random ones. The multiples of participants have varieties of motivations and strategies that the market’s logic cannot be coordinated and boiled down to one specific motive. This is why one strategy or logic cannot be driving the market.

Who is Winning? Who is Losing?

There could be some logic that may work out. Previously, it was discussed that there could not be, but let’s say there are. These logics would then become known through common knowledge. Yet, this title “Common knowledge is a trap” has given the answer away.

It’s quite a statement to make and even to mention quite boldly. But it is truly possible because the market is a zero-sum game. A trader could arrive at the arena to buy from sellers and sell to buyers. This means a trader would need someone to do the exact opposite of him/her at the same time. So imagine that you do a trade. In a sense, you would like to succeed at the expense of the person you have done the trade with. You will think that you are the winner while he/she is the loser. But in the other trader’s mind, he/she is the winner and you are the loser. So who is correct?

The Trading Trap

Common knowledge could then definitely be a trap because there are different types of participants in the market. Most of us are simple traders with no ability to affect market prices or market moves. This is because our money is not heavy enough to affect large liquidated markets.

However, there are some who can affect the price and influence the market. This is the game of the large institutions. They have huge capital which can move markets and by placing orders it will cause a reaction in price. They can make impressions, all kinds of traps and false momentum games around common knowledge.

What is this Common Knowledge?

Common knowledge is pretty much all the ideas that are thrown around in classrooms and the simple/beginner’s market education. Basically, it’s Fibonacci, trend lines, daily pivot levels around moving averages like MA200 and EMA100, etc.

Professional traders know how to work around these indicators, and also know how common knowledge instructs traders to act upon.

Tricks from The Pros

One of the main tricks that the Hedge Funds and large institutions etc. prefer to engage in, is to occasionally allow these common knowledge strategies to work for them. They’re then able to cash money out of these strategies over and again. This creates the false illusion that common knowledge strategies do consistently work.

But if you don’t have enough capital to affect prices, you are entirely subject to the moves of those who do have enough. This is why common knowledge can act as a trap.

A Wealth of Logic

“You can be the best analyst in the world, but in actual trading, you can be wrong many times” Another reason why strategies can fail is that there are thousands of different logics, some of which contradict the others. Some are momentum strategies that try to catch an already moving market, while others are trying to catch reversals. Some are playing the opposites, while others are playing the positives.

The same strategies applied to different timescales and can also contradict themselves. It depends on the trade scope, to determine whether you’re long or short for the same trade vehicle. These endless amounts of participants with different strategies and time-frames create a chaotic and un-explainable logical system. You can be the best analyst in the world, but in actual trading, you can be wrong many times.

It’s All About Risk Management

Even if you can predict the major moves of the market, your success ultimately depends on how you enter trades according to your risk management strategy.

If you’re able to predict major moves, sometimes you can’t measure the drawdown or the opposite movement that will happen before it moves in your direction. Even so, you won’t have the money or patience to hold on until it turns.

Final Tips

Always know that whatever you predict for the forex market, may not be final. Use your trading plan which is tailored to your prediction but should still have the flexibility to shift if needed. Be open-minded in case the market moves from the preferred position. Be aware of all the variables that can sabotage your plan. Always be prepared to change your plan if something goes wrong. Don’t go all-in, nor be stubborn. Never feel the need to prove your prediction right. Once you enter the market, act on what it shows you. Be flexible and open to changing the course in case of market shifts.

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+++ Best Forex Signal : How to win with mechanical trading systems

Best Forex Signal -

Much ink has been devoted to pinpointing the causes of mechanical trading systems failures, especially after the fact. Although it may seem oxymoronic (or, to some traders, simply moronic), the main reason why these trading systems fail is because they rely too much on the hands-free, fire-and-forget nature of mechanical trading. Algorithms themselves lack the objective human oversight and intervention necessary to help systems evolve in step with changing market conditions.

Mechanical trading systems failure, or trader failure?

Instead of bemoaning a trading-system failure, it’s more constructive to consider the ways in which traders can have the best of both worlds: That is, traders can enjoy the benefits of algorithm-managed mechanical trading systems, such as rapid-fire automatic executions and emotion-free trading decisions, while still leveraging their innate human capacity for objective thinking about failure and success.

The most important element of any trader is the human capability to evolve. Traders can change and adapt their trading systems in order to continue winning before losses become financially or emotionally devastating.

Choose the right type and amount of market data for testing

Successful traders use a system of repetitive rules to harvest gains from short-term inefficiencies in the market. For small, independent traders in the big world of securities and derivatives trading, where spreads are thin and competition fierce, the best opportunities for gains come from spotting market inefficiencies based on simple, easy-to-quantify data, then taking action as quickly as possible.

When a trader develops and operates mechanical trading systems based on historical data, he or she is hoping for future gains based on the idea that current marketplace inefficiencies will continue. If a trader chooses the wrong data set or uses the wrong parameters to qualify the data, precious opportunities may be lost. At the same time, once the inefficiency detected in historical data no longer exists, then the trading system fails. The reasons why it vanished are unimportant to the mechanical trader. Only the results matter.

mechanical trading rules

Pick the most pertinent data sets when choosing the data set from which to create and test mechanical trading systems. And, in order to test a sample large enough to confirm whether a trading rule works consistently under a wide range of market conditions, a trader must use the longest practical period of test data.

So, it seems appropriate to build mechanical trading systems based on both the longest-possible historical data set as well as the simplest set of design parameters. Robustness is generally considered the ability to withstand many types of market conditions. Robustness should be inherent in any system tested across a long time range of historical data and simple rules. Lengthy testing and basic rules should reflect the widest array of potential market conditions in the future.

All mechanical trading systems will eventually fail because historical data obviously does not contain all future events. Any system built on historical data will eventually encounter ahistorical conditions. Human insight and intervention prevents automated strategies from running off the rails. The folks at Knight Capital know something about live trading snafus.

  Simplicity wins by its adaptability

Successful mechanical trading systems are like living, breathing organisms. The world’s geologic strata are filled with fossils of organisms which, although ideally suited for short-term success during their own historical periods, were too specialized for long-term survival and adaptation. Simple algorithmic mechanical trading systems with human guidance are best because they can undergo quick, easy evolution and adaptation to the changing conditions in the environment (read marketplace).

Simple trading rules reduce the potential impact of data-mining bias. Bias from data mining is problematic because it may overstate how well a historical rule will apply under future conditions, especially when mechanical trading systems are focused on short time frames. Simple and robust mechanical trading systems shouldn’t by affected by the time frames used for testing purposes. – The number of test points found within a given range of historical data should still be large enough to prove or disprove the validity of the trading rules being tested. Stated differently, simple, robust mechanical trading systems will outshine data-mining bias.

If a trader uses a system with simple design parameters, such as the QuantBar system, and tests it by using the longest appropriate historical time period, then the only other important tasks will be to stick to the discipline of trading the system and monitoring its results going forward. Observation enables evolution.

On the other hand, traders who use mechanical trading systems built from a complex set of multiple parameters run the risk of “pre-evolving” their systems into early extinction.

Build a robust system that leverages the best of mechanical trading, without falling prey to its weaknesses

It’s important not to confuse the robustness of mechanical trading systems with their adaptability. Systems developed based on a multitude of parameters led to winning trades during historical periods – and even during current observed periods – are often described as ‘robust.’ That is no a guarantee that such systems can be successfully tweaked once they have been trade past their “honeymoon period.” That is an initial trading period during which conditions happen to coincide with a certain historical period upon which the system was based.

Simple mechanical trading systems are easily adapted to new conditions, even when the root causes of marketplace change remain unclear, and complex systems fall short. When market conditions change, as they continually do, the trading systems which are most likely to continue to win are those which are simple and most-easily adaptable to new conditions; a truly robust system is one which has longevity above all.

Simple algorithmic mechanical trading systems with human guidance are best because they can undergo quick, easy evolution and adaptation to the changing conditions in the environment (read marketplace).

Unfortunately, after experiencing an initial period of gains when using overly-complex mechanical trading systems, many traders fall into the trap of attempting to tweak those systems back to success. The market’s unknown, yet changing, conditions may have already doomed that entire species of mechanical trading systems to extinction. Again, simplicity and adaptability to changing conditions offer the best hope for survival of any trading system.

Use an objective measurement to distinguish between success and failure

A trader’s most-common downfall is a psychological attachment to his or her trading system. When trading-system failures occur, it’s usually because traders have adopted a subjective rather than objective viewpoint, especially with regard to stop-losses during particular trades.

Human nature often drives a trader to develop an emotional attachment to a particular system, especially when the trader has invested a significant amount of time and money into mechanical trading systems with many complex parts which are difficult to understand. However, it’s critically important for a trader to step outside the system in order to consider it objectively.

In some cases, the trader becomes delusional about the expected success of a system, even to the point of continuing to trade an obviously-losing system far longer than a subjective analysis would have allowed. Or, after a period of fat wins, a trader may become “married” to a formerly-winning system even while its beauty fades under the pressure of losses. Worse, a trader may fall into the trap of selectively choosing the testing periods or statistical parameters for an already-losing system, in order to maintain false hope for the system’s continuing value.

An objective yardstick, such as using standard deviation methods to assess the probability of current failure, is the only winning method for determining whether mechanical trading systems have truly failed. Through an objective eye, it’s easy for a trader to quickly spot failure or potential failure in mechanical trading systems, and a simple system may be quickly and easily adapted to create a freshly-winning system once again.

Failure of mechanical trading systems is often quantified based on a comparison of the current losses when measured against the historical losses or drawdowns. Such an analysis may lead to a subjective, incorrect conclusion. Maximum drawdown is often used as the threshold metric by which a trader will abandon a system. Without considering the manner by which the system reached that drawdown level, or the length of time required to reach that level, a trader should not conclude that the system is a loser based on drawdown alone.

Standard deviation versus drawdown as a metric of failure

In fact, the best method to avoid discarding a winning system is to use an objective measurement standard to determine the current or recent distribution of returns from the system obtained while actually trading it. Compare that measurement against the historical distribution of returns calculated from back-testing, while assigning a fixed threshold value according to the certainty that the current “losing” distribution of mechanical trading systems is indeed beyond normal, to-be-expected losses, and should therefore be discarded as failed.

So, for example, assume that a trader ignores the current drawdown level which has signaled a problem and triggered his investigation. Instead, compare the current losing streak against the historical losses which would have occurred while trading that system during historical test periods. Depending upon how conservative a trader is, he or she may discover that the current or recent loss is beyond, say, the 95% certainty level implied by two standard deviations from the “normal” historical loss level. This would certainly be a strong statistical sign that the system is performing poorly, and has therefore failed. In contrast, a different trader with greater appetite for risk may objectively decide that three standard deviations from the norm (i.e. 99.7%) is the appropriate certainty level for judging a trading system as “failed.”

The most important factor for any trading systems’ success, whether manual or mechanical, is always the human decision-making ability. The value of good mechanical trading systems is that, like all good machines, they minimize human weaknesses and empower achievements far beyond those attainable through manual methods. Yet, when properly built, they still allow firm control according to the trader’s judgment and allow him or her to steer clear of obstacles and potential failures.

Although a trader can use math in the form of a statistical calculation of standard distribution to assess whether a loss is normal and acceptable according to historical records, he or she is still relying on human judgment instead of making purely-mechanical, math-based decisions based on algorithms alone.

Traders can enjoy the best of both worlds. The power of algorithms and mechanical trading minimizes the effects of human emotion and tardiness on order placement and execution, especially with regard to maintaining stop-loss discipline. It still uses the objective assessment of standard deviation in order to retain human control over the trading system.

Be prepared for change, and be prepared to change the trading system

Along with the objectivity to detect when mechanical trading systems change from winners into losers, a trader must also have the discipline and foresight to evolve and change the systems so they can continue to win during new market conditions. In any environment filled with change, the simpler the system, the quicker and easier its evolution will be. If a complex strategy fails, it may be easier to replace than to modify it, while some of the simplest and most-intuitive systems, such as the QuantBar system, are relatively easy to modify on-the-fly in order to adapt to future market conditions.

In summary, it can be said properly-built mechanical trading systems should be simple and adaptable, and tested according to the right type and amount of data so that they will be robust enough to produce gains under a wide variety of market conditions. And, a winning system must be judged by the appropriate metric of success. Instead of merely relying on algorithmic trading rules or maximum drawdown levels, any decision about whether a system has failed should be made according to the trader’s human judgment, and based on an assessment of the number of standard deviations of the system’s current performance when measured against its historic-test losses. If mechanical trading systems are failing to perform, the trader should make the necessary changes instead of clinging to a losing system.

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How to Manage the Emotions of Trading

Knowing how to control emotions while trading can prove to be the difference between success and failure. Your mental state has a significant impact on the decisions you make, particularly if you are new to trading, and keeping a calm demeanor is important for consistent trading. In this piece, we explore the importance of day trading psychology, for both beginner and more experienced traders, and give some pointers on how to trade without emotions.

The Importance of Controlling Emotions While Trading

The importance of day trading emotional control cannot be overstated.

Imagine you’ve just taken a trade ahead of Non-Farm Payrolls (NFP) with the expectation that if the reported number is higher than forecasts, you will see the price of EUR/USD increase quickly, enabling you to make a hefty short-term profit.

NFP comes, and just as you had hoped, the number beats forecasts. But for some reason, price goes down!

You think back to all the analysis you had done, all the reasons that EUR/USD should be going up – and the more you think, the further price falls.

As you see the red stacking up on your losing position, emotions begin to take over – this is the ‘Fight or Flight’ instinct.This impulse can often prevent us from accomplishing our goals and, for traders, this issue can be very problematic, leading to knee-jerk reactions.

Professional traders don’t want to take the chance that a rash decision will damage their account – they want to make sure that one knee-jerk reaction doesn’t ruin their entire career. It can take a lot of practice, and many trades, to learn how to minimize emotional trading.

The 3 Most Common Emotions Traders Experience

Some of the most common emotions traders experience include fear, nervousness, conviction, excitement, greed and overconfidence.

Fear/Nervousness

A common cause of fear is trading too big. Trading with improper size magnifies volatility unnecessarily and causes you to makemistakes you normally wouldn’t make if you weren’t under the stress of risking larger losses than normal.

Another culprit for fear (or nervousness) is you are in the ‘wrong’ trade, meaning one that doesn’t fit your trading plan.

Conviction/Excitement

Conviction and excitement are key emotions you’ll want to feed off, and you should feel these in every trade you enter. Conviction is the final piece of any good trade, and if you don’t have a level of excitement or conviction then there is a good chance you are not in the ‘right’ trade for you.

By ‘right’ we mean the correct trade according to your trading plan. Good trades can be losers just as bad trades can be winners. The idea is to keep yourself winning and losing on only good trades. Making sure you have conviction on a trade will help ensure this.

Greed/Overconfidence

If you find yourself only wanting to take trades that you deem as possible big winners, you could be getting greedy. Your greed may have been the result of doing well, but if you aren’t careful you may slip and end up in a drawdown.

Always check that you are using proper trade mechanics (i.e. sticking to stops, targets, good risk/management, good trade set-ups). Sloppy trading as a result of overconfidence can end a strong run.

Learn more about managing greed and fear while trading.

DailyFX Analyst Nick Cawley on Losing Discipline

Nick Cawley has more than 20 years’ experience in the markets and trades a variety of fixed-income products.

“My worst trades – and there have been a few of them – have all been when my best laid plans are thrown out of the window when I lose discipline.

‘I didn’t use correct set-ups and stops; I thought I was ’better’ than the market; I doubled up when I was losing and lost more, and I put more money into my trading account to chase my losses.

‘I lost control of my emotions and traded when I should have looked without any emotion at my position and cut them and moved on. Easy to say, difficult to do, but a must for any trader who is looking for long-term success.”

How to Control Emotions While Trading: Top Tips and Strategies

Planning out your approach is key if you want to keep negative emotions out of your trading. The old adage ‘Failing to plan is planning to fail,’ can really hold true in financial markets.

As traders, there isn’t just one way of being profitable. There are many strategies and approaches that can help traders accomplish their goals. But whatever is going to work for that person is often going to be a defined and systematic approach; rather than one based on ‘hunches.’

Here are five ways to feel more in control of your emotions while trading.

1. Create Personal Rules

Setting your own rules to follow when you trade can help you control your emotions. Your rules might include setting risk/reward tolerance levels for entering and exiting trades, through profit targets and/or stop losses.

2. Trade the Right Market Conditions

Staying away from market conditions which aren’t ideal is also prudent. Not trading when you aren’t ‘feeling it’ is a good idea. Don’t look to the market to make you feel better; if you aren’t up to trading the simple solution may just be to step away.

3. Lower Your Trade Size

One of the easiest ways to decrease the emotional effect of your trades is to lower your trade size.

Here’s an example. Imagine a trader opens an account with $10,000. Our trader first places a trade for a $10,000 lot on EUR/USD.

As the trade moves at $1 a pip, the trader sees moderate fluctuations in the account. An amount of $320 was put up for margin, and our trader watches their usable margin of $9,680 fluctuate by $1 per pip.

Now imagine that same trader places a trade for $300,000 in the same currency pair.

Now our trader has to put up $9,600 for margin – leaving them with only $400 in usable margin – and now the trade is moving at $30 per pip.

After the trade moves against our trader only 14 pips, the usable margin is exhausted, and the trade is closed automatically as a margin call.

The trader is forced to take a loss; they don’t even have the chance of seeing price come back and pull the trade into profitable territory.

In this case, the new trader has simply put themselves in a position in which the odds of success were simply not in their favor. Lowering the leverage can greatly help diminish the risk of such events happening in the future.

4. Establish a Trading Plan and Trading Journal

In terms of fundamental factors, planning for various outcomes in the runup to key news events may also be a strategy to bear in mind.

The results between new traders using a trading plan, and those who don’t can be substantial. Compiling a trading plan is the first step to attack the emotions of trading, but unfortunately the trading plan will not completely obviate the effects of these emotions. Keeping forex trading journals may also be helpful.

5. Relax!

If you’re relaxed and enjoy your trading, you will be better equipped to respond rationally in all market conditions.

Further Resources to Manage Emotions and Support Your Trading

For more information on managing your emotions when trading, check out our free trading guide Traits of Successful Traders, with exclusive insights from DailyFX analysts. Also on the subject, the following articles may be helpful

Master the concept of greed-free trading

3 Trading Exit Strategies

3 Things I Wish I Knew When I Started Trading Forex

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