Examining Draw Downs When Selecting A Forex Signal Provider
To begin, let us define the term Draw Down. A draw down is the total amount lost between an extreme high and an extreme low and is the very first thing a person seeking a third party signal provider should pay close attention to. The draw down amount encompasses open positions without taking into account the margin required to prevent a margin call. The burning question becomes then how much draw down is too much draw down? Like many questions asked of the trading business, the answer is - it depends. This is not a cut and dried circumstance; many factors abound in the answer to this question. A person with an account of many thousands of dollars can obviously tolerate more draw down than a person with less, but what else is entailed in the answer?
Another thing to look at aside from the actual number is how that number came to be. If a trader has a draw down that is too high for you to tolerate but otherwise seems to trade well, you should look at how many positions he opens at a time. If that trader opens 5 trades on any given pair at a time you can instantly cut their historical draw down by 5. Limiting the # of open trades for a trader could drastically reduce the overall draw down.
A trader can often have an excellent historical track record except for one single mega-meltdown, where the trader simply zoned out and let a trade run amok on him and unmonitored for days on end. This will reflect badly on him but really should not overly affect the scope of the trader's abilities. What if the trader simply can't tell when a trade has a snowball's chance in hell of making a comeback to even? What if, heaven forbid, his internet connection lost it at the most inauspicious times? In either case, avoid this problem by setting your own stops for the trader. Don't though, stop those trades that are reasonable, stop only those that are beyond the outer rim of a realistic (to you) trading range.
At this point, we are going to visit again our original question. Now that you have accomplished all you can to limit draw down, I will caution you by saying any amount over 35% of your total account equity is way overdoing it. If you let yourself become in a situation where a 50% plus loss is incurred, coming back from it would involve some extremely risky behavior. A 50% loss demands a 100% gain just to get back on the level.
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.