28 Mar How to Reduce Drawdown Without Using a Stoploss
How to Reduce Drawdown Without Using a Stoploss
March 28th, 2018
As we talked about last week, winning every series of trades is a marvelous thing.
If we want to be successful, we can’t quit.
And nobody quits if we’re winning all the time.
Which is why trading systems with no stoplosses are great.
But we know that there’s a downside to winning all the time. The downside comes when things go badly.
On one hand, the lack of a stoploss gives our trade the time to recover and end in profit.
On the other hand, the lack of a stoploss also gives our trade the time to move against us and destroy our whole account.
How do we stop that destruction?
Well, we could use a stoploss.
But if we do that, our winning diminishes, our resolve diminishes, and we’ve lost the one thing that’s most attractive about trading this way.
So is there anything else we can do?
We could have a time limit.
When we trade without a stoploss, we not only win every series of trades (as long as we don’t lose everything, of course), but we win quickly.
Going for a small profit target and not using a stop combines to give us quick success. For example, in my Fair Value system, trades are closed out in profit within 24 hours around 90% of the time.
If that’s the case, why not end it there?
Unless it’s the Swiss Franc Flash Crash of January, 2015, nothing is going to take our whole account in one day.
When trading without stops, if it’s going to go badly it’s going to be a long, drawn-out process. The trade will go the wrong way and then level off and then go the wrong way again and on and on. The path to to a margin call is slow and tortuous.
What if we never allow that to happen?
What if we only give our trades a short amount of time to work out? If we get one of our fast winners, then that’s great.
If we don’t win right away, let’s not let anything get out of hand. Let’s just cut off the whole process after a certain amount of time has elapsed.
Does that make a difference?
It did for the USDCAD.
Last week, I talked about how a USDCAD trade went into a drawdown for nine months before finally closing out in profit.
That’s a long time. And if we used a trade size that was too large, at some point in that nine month journey, we could have lost the account.
What would happen if we only gave our USDCAD trades about a day to work themselves out? What do those numbers look like?
Of course, if we limit the amount of time our trades have to work out, we’re going to lose some slow-moving winners. But hopefully it’s worth it.
To the results.
If we keep everything the same but limit our trading period to about one full day, not surprisingly, our total profit drops about 40%.
As expected, we lose some winning trades if we limit the time we trade.
But if we keep everything the same but only trade for a day, the max drawdown drops 89%!
By not letting the USDCAD slowly move against us for a long time, we lower drawdown by an extraordinary number.
Is lowering profit by 40% worth having our max drawdown drop 89%? That’s something we have to decide.
One more thing.
Using a time exit works best for slow-moving instruments.
For example, the AUDJPY is the exact opposite of slow-moving. If we use the same time exit on AUDJPY, we don’t lower drawdown at all. It’s almost exactly the same.
Profit gets lower, though. By using a time limit, our profits would actually decrease by 92%. Yikes.
Obviously, a pair like the AUDJPY does best with no limits whatsoever. It needs time and space to be effective.
So keep that in mind.
Each financial instrument has its own personality and each must be treated accordingly.
But if we want the joy of winning all the time and want our drawdown to be much lower, putting a time limit on lethargic currency pairs might be a good option.
It sure seems to be for the USDCAD.