We all know that draw down is not a good thing. You wake up, you turn on your computer and you see that your account is down some percent of its initial equity. You are losing money and losing is not a good sensation, you feel like a downright loser, you feel that you are doing things wrong and you don’t want to run this system anymore because you fear it may drain your account even more. The answer to this instinct is to look for systems which have the smallest periods of draw down and the longest periods of profitability.
However you have to understand that the market exposure of a given system cannot be eliminated magically mainly because the future cannot be predicted. So for any given system you make, you will eventually have to pay the price of being wrong when you think the market will develop somehow and it develops in another way. People then try to make systems which are what I call “stubborn systems” which are reluctant to let the market cash their market exposure. These systems may avoid taking losing at all (no stop loss), increase their lot size after losing (D’Alemberts, Martingales, etc) or aim to win very little each time so that the odds of winning are extremely low (very unfavorable risk to reward ratio).
The truh is that these systems WILL have a high like hood of starting at a profitable place. It is very likely that people trading these systems for the first month or two will have a very high probability of getting into profitable trades. Draw down periods will almost never happen or – in the case of systems which do not take an exit or SL – they will only happen once, when the account is wiped. Moreover, systems with very small TP and very large SL values with very unfavorable risk to reward ratios are likely going to give unrealistic profit targets in backtesting due to the fact that one minute interpolation errors and the lack of execution problems – which do exist in live trading – will embelish their performance significantly.
Draw downs are not something that can be eliminated or made “very small”. All the successful systems I have known in my life have extensive and sometimes deep draw down periods which are extremely difficult to handle for anyone trading them, reason why confidence and understanding becomes VITAL when handling these systems. In fact, holding a small draw down for a long period of time may be hard for most people. Imagine waking up and looking at a 5-15% draw down every day for one year, how would you feel ? Most people would say “this doesn’t work” and they would archive the system when they probably don’t even understand the system they are actually trading and its normal draw down / profit cycles.
I have found that this is one of the great defenses the market has towards everybody living from or using automated trading systems successfuly. Stubborn systems do not work but they are the systems most people are most likely to use while long term profitable systems are extremely hard to use and very non-rewarding (from a psychological point of view) and difficult to trade reason why only very few people actually use them. In the end, the people who search for stubborn systems and neglect to accept the fact that draw downs – sometimes even extensive and deep – are necessary to achieve long term profits and sustained growth will not be profitable while the few people who can accept this fact will in the end achieve success (not easily by the way !). What did they say about that person who laughed last ? :o)
If you would like to learn more about my journey in automated trading and how you too can design and program your own systems to achieve long term success in automated trading please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !