Worst Case Scenarios

Discussion in 'Forex' started by Ituglobal, Feb 3, 2012.


    “Periods of drawdown occur in every strategy, accept this as fact and move on.” – Ryan Schofield
    “There’ no such thing as the best trading strategy. For a successful trader it’s far more important to employ different trading strategies simultaneously. There are good and bad times for every strategy.” – Frank Hassler


    While using a strategy in the markets, if we want to be perfectionists and look for all the small pieces, we’ll be overwhelmed by information overload. The optimum way to trade the currency markets, making returns using a speculation method, is to first understand that the awaited results from each trade is random, but over a great number of trades the average profit for each trade would possibly be positive, i.e. trading currency mechanically is a game of randomness with a positive statistical expectancy. As a result, the trader is usually well off not reducing the amount of positions signaled by a particular method, for there’s no way to know in advance which orders would bring more profit.

    Certainly, historical returns aren’t a guarantee of the future outcome and bear it in mind that during spectacular changes in the market movements, a technique may generate unwanted results. Even the pros sometimes run with the herd and may be wrong at extreme points. That’s why a trader would wisely decide on a small and safe position sizing and use stops to control risk.

    Let’s learn some lessons from Mr. Frank. Please let’s check the information below and learn some lessons from it.

    Frank Hassler’s Recent Trading Results:
    2001: 58.5%
    2002: 179.5%
    2003: 81.1%
    2004: 46.0%
    2005: 25.9%
    2006: 9.4%
    2007: 85.4%
    2008: -9.2%
    2009: 113.7%
    Number of trades: 422
    Maximum drawdown: -42.77%
    Hit rate: 55.45%

    Lessons from the performance above: 1) It took Mr. Frank about 9 years to make hundreds of percentage. However, this is what most traders want to make in a few months. 2) Despite the fact that the performance above is contrary to the expectation of most traders, the track record is good. The strategy has survived many odds and uncertainties in the markets. 3) There was a very good year like the year 2002, but this didn’t make the trader become overconfident to the point of increasing his position sizing irrationally. 4) In the year 2006, Mr. Frank only made a profit of 9.4%. That year must be difficult, though some profit was still made – no matter how small. I may even be thankful for 5% profit per year. The safety of my account is the most important. A greedy trader who thought his own account was too small would’ve preferred 10% profit per day rather than close to 10% per year; which was made by Mr. Frank in the year 2006. But this could have resulted in 10% loss per day in a protracted losing streak. 5). There was a bad year like the year 2008 [though certain traders made profits]. While many traders received margin calls or suffered colossal reduction in their accounts, Mr. Frank didn’t go down more than -9.2%. This made it easier for him to recover the loss and gain over 100% in the following year. 6). Some greedy traders who hated to use small position sizing because they think their capital was too small would’ve abandoned their strategy for another one or even abandoned trading altogether, because a whole year’s labor showed an overall loss. They couldn’t imagine trading for a whole year without declaring a profit. Without a profit, they’d think trading wasn’t for them – irrespective of the fact that they made a profit in the past. Mr. Frank was thankful that he didn’t go down too much during his bad year. He was thankful for the past blessings and the future hopes. He knew that capital preservation is more important than profits. 7) Mr. Frank’s maximum drawdown was up to -42.45%: This means he’d periods of protracted losses and bad markets. Many a childish trader abandons a good signals generator because of a week or a month’s losses. Yet Mr. Frank wasn’t disheartened or nor did he curse trading or lost hope. He’s an overall winner – a survivor that wasn’t swallowed by the uncertainties of the markets.

    In addition to the lessons mentioned above, an equity curve graph of a vigorously traded account was attached with this article. You can see the results of many winning trades and losing trades, plus how the pips that were gained outnumbered the pips that were lost. There were heavy losses, yet the account has moved up by roughly 40% in 8 months. No matter the strategy you use, losses are inevitable, but an astute trader would stick to his positive expectancy rules (These are constantly mentioned in my articles). This is a fact in trading; and facts are sacred. Your equity curve can’t go up in a straight line. It will be characterized by occasional dips – followed by a rise in the curve (provided that you’re using a positive expectancy system).

    What was your worst case scenario? Was it 2% reduction in your account or 20% reduction? Was it 5% reduction in your account or 50% reduction? Was it 7% roll-down or 85% or even a margin call? How many times have you made substantial gains, only to suffer a huge roll-down because a particular market condition wasn’t favorable to your strategy? How many margin calls have you received? When would you get out of this?
    Are You Part of the Problem or Part of the Solution?
    We must recognize a key fact about our conscience, the inner voice that tells us whether our actions are right or wrong. Everyone has such inner voice… but it’s not necessarily trustworthy. One of the most erroneous trading thoughts is to expect that a foolproof trading system exists somewhere. Are you part of the problem or part of the solution? Those who tell people that trading is easy , depicting a particular system as the Golden Goose strategy, telling people that they need a very short training and telling them about the big profit they can make without risk control measures that work, are clearly part of the problem plaguing the trading world. Those who tell the truth about trading, showing the way out of the deadlock that would be encountered in this profession, depicting risk control as the key to survival and helping people reach their highest trading potential, are vividly a blessing to the trading world.

    Are you part of the problem or part of the solution?

    This article is concluded with some quotes from Bill Provenzano:

    1. “If you perceive every movement of the market as an opportunity, you will drive yourself mad! It is only your High Probability Trades that are your legitimate trading opportunities.”

    2. “You can’t change your past poor trading decisions, behaviors, or outcomes. But you can learn from them to help shape your future success. You can admit that you tend to think with skewed perceptions about outcomes that, in the end, are simply a functional part of your trading system and Trading Business Plan. When you understand that it is human nature to think in these counterfactual ways, you empower yourself to take control of these thoughts and dismiss them as skewed perception. The best part is you don’t have to wait four years… The next trading opportunity is just ahead.”

    3. “A successful trading business is built upon the understanding that not every trade will be a winner. In fact, it is possible that a successful Trading Business Plan can include a set of High Probability Trades that either break-even or incur a small loss 50% of the time. And yes, some of those small losses will be generated by stops that are triggered to the tick. Many more of those losses, though, will be generated by market movement that goes significantly.”

    Your questions and opinions are highly welcome.

    Thank you.

    With best regards,

    Azeez Mustapha