So, you are in the market for a third party signal provider. The maximum draw down of the trader is your first step in the selection process. To define the maximum draw down – this is the gap between the ultimate amount of loss between the absolute top and the absolute bottom. Included in this number is also the open positions, but not included is the account margin necessary to keep you away from a margin call. How much is too much of a draw down you may well ask. Of course, like many answers to many questions, it is – That depends. Many, many issues need to be examined when coming up with an answer to this very important question. It goes without saying that a person with an account in the high thousands of dollars can stand more of a draw down than a person with a much smaller account. So, that being said, what are some other things to consider?
Besides the size of the draw down number are the events that formulated it. A trader with a draw down of a size so high it makes you nervous but otherwise seems a successful one, you need to take a look at the number of positions he has open at one time. If he opens 5 trades on whatever pair at one time; you can immediately reduce his record of draw downs by 5. The trader who limits the number of open trades can sizably cut down the overall draw down.
Sometimes you will find a trader who has a great track record aside from one major meltdown where a single trade ran out of control for days unchecked. This will produce an abnormal draw down in relation to the trader’s real ability. He may be the kind of guy who can’t recognize when a trade has no chance of coming back to even. He may also be a guy who lost his internet connection at an inopportune time once or twice. Either way you can keep this trader from doing this to your account by setting your own stops for him. Just make sure that you only stop out his trades that are well out of a realistic trading range.
Time to return to the question that began this article. Once you have done all you possibly can to limit draw down, my feeling is that any number over 35% of your total account equity is exorbitant. If you get into a set of circumstances where you are suffering a 50% or greater loss, it is well nigh impossible to ever recover from those losses without undertaking risk in the extreme. Think about it. Do the math. If you suffer a 50% loss, you need to make a 100% recovery just to break even.
Another item to look for when considering draw down is the history (or lack of history) available on the trader(s) you are researching. You want to uncover as much history as possible so you may determine how he handles himself when things get rough, because they are sure to do so.
You must constantly monitor your traders on all of your accounts, whether live or demo. Should any draw down run rampant, you will need to reevaluate and possibly delete the trader from your active portfolio.
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