Have you ever said to yourself, "Well, going long (or short) the EUR/USD looked good at the time I took the trade!"
Perhaps you've had an experience where for the past several weeks, you've been haplessly watching a poor little EUR/USD trade spiral out of control to the point where you can hardly contain pulling your hair out by the roots. You’ve witnessed this innocent little trade morph into a horrifying beast which you are now referring to as the "drawdown monster."
We’ve all been there, haven’t we? Paralyzed by fear or -- if you’re anything like me sometimes -- just stubbornly unwilling to admit defeat and close the darn trade. It’s a difficult thing to confess when we’re wrong, but at what point do we say enough is enough?
So, the question is simply this—what should my next move be? How long should I hang onto this trade that just seems to be going from bad to worse to absolute train wreck? Should I cut my losses and consider it a painful lesson learned or do I hang on to this bad boy and hope it comes back? Stranger things have happened, right?
Well, let’s put something into perspective.
Losing Money
Let’s say I have $10,000 in my margin account and I lose $5,000. My drawdown in this case would be 50 percent. Now, what percentage of that $5,000 would I have to make in order to get back my original $10,000? 50 percent, right? Wrong! I would have to make back 100 percent of my $5,000 to get back to my original $10,000!
The point of this harrowing example is this—it’s very easy to lose money and a whole lot harder to get it back.
“But Rob, I would never lose 50% of my account in one trade.” For your sake, I certainly hope not. But for the sake of argument, let’s just say you do. How on earth do you get yourself out of this pickle?
Perhaps this question is best answered through the sad and forlorn tale of my good friend and currency trader, Shasty McButterknuckle, who is actually the alter-ego personality of a member of the marketing department at IBFX.
Shasty has a heart as good as his intentions, but he perpetuates three tendencies that seem to get him in trouble and constantly keep him in the red:
Tendency #1—A little thing called pride!
Shasty has a penchant for hanging on to trades for nothing more than his heightened sense of ego. He is so committed to proving that his original decision was right that he's willing to stubbornly cling to it until the very end. And interestingly enough, the more pips he loses, the more convinced he is that his original premise was justifiable. Shasty holds on to losers in an effort to prove that he was right—both in his own eyes and in the eyes of others.
Solution: There should ALWAYS be a reason for your trading moves. A decision based on ego will inevitably come back to haunt you. A trader who fails to maintain a strict trading plan won’t know where to exit a trade or how much money he could make or lose. This “fly by the seat of your pants” style trading more often than not leads to disappointment and frustration.
Tendency #2—Adding to losing positions
Shasty sometimes not only holds on to a losing trade but also actually adds positions to it, rationalizing that his targets will be hit when the currency changes direction. Of course, this method is super-terrific if the currency does, indeed, change direction, but if it doesn't and he maintains that losing position, it simply hastens the painful demise of that poor little trade.
Solution: Adding to losing positions in order to “save yourself” is an entirely different ballgame than doing so because it’s a valid part of your trading strategy. If a trader is adding positions for the right reason, the key to remaining competitive lies squarely within his psychological ability to ride out a big drawdown—a feat that should never be taken lightly—and then allowing the trade to reach its maximum potential.
Tendency #3—Loyalty
Perhaps Shasty's biggest downfall is his undying love and commitment to a particular currency pair. In this case, his strength is also his weakness. His sense of loyalty holds him back from making sound, educated trading decisions.
Solution: Fundamentally speaking, your feelings about a given currency pair don’t mean squat. The key to remaining competitive in Forex trading is allowing the market to tell you about the currency and then pouncing, not vice versa. Give more weight to what is happening in the market than to your attachment to the pair.
So, we find ourselves back at the beginning—Riding a losing trade and wondering what to do next.
A dear friend once told me, “Wise people learn from their own mistakes, but super wise people learn from the mistakes of others.” So what can we learn here? Firstly, don’t trade like Shasty! Be ye not so foolish. Learn from his mistakes and your margin account will thank you.
Secondly, take heed to these sound trading principles:
- Grasp a bigger picture perspective on the market. Before you begin trading for the day, have a look at the weekly and/or monthly chart. They can often provide you a broader perspective of a particular currency pair.
- Accept responsibility for your own actions. When you have a losing trade, don’t look for others to blame. You made the decision to place the trade. You control your trading destiny. You and you alone.
- Maintain a strict adherence to sound money management. Buying into the “get rich quick” scheme of Forex trading has left countless numbers of traders with dwindled margin accounts. Manage your assets well and you will be a much happier—and much more competitive—currency trader.
We’re experiencing a once-in-a-decade event in the Forex market, my friends, and it isn’t going away anytime soon. An extraordinary confluence of events has thrown nearly every financial market into chaos and, sadly, Forex was not immune. I’m reminded of a rather macabre but ever so appropriate phrase I once heard that went a little something like this—adapt or die.
Drawdown is a painful reality in Forex trading and despite how much you punch, kick, and fight, it will undoubtedly happen to you at some point. It’s up to you to decide how you’ll handle it. It can make you angry and vengeful or it can make you wiser and more disciplined. I can’t speak for you but I most certainly prefer the latter.
As fellow currency traders, we always welcome your thoughts, comments and questions. We’re always here to help.
Happy trading!
Corbin (from the U.S.)
Rob (from Dubai, UAE)
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