Technical Analysis  

HOW DRAWDOWN MINIMIZER LOGIC
CAN REDUCE DRAWDOWNS AND RISK

This information reveals an amazing method to reduce risk by staying in good trades, but trading with small stops to avoid large losses.

Usage of stop-loss orders is normally critical to trading success. The most famous trader of all time, Mr. W. D. Gann, said repeatedly in his books and commodity course that it's always critically important to place a stop-loss order on each trade you make. That way bad signals and losing trades will not likely wipe out your trading capital, thanks to your stop-loss order giving you some protection.

Most systems and most trading methods require fairly large stop-loss orders. That is because stops are frequently based on one or more of the following logical, however frequently unsuccessful methodologies:

a. Place a stop at a pre-determined percentage of the true daily trading range. For example, if the true daily range or average of recent true ranges (High minus Low, plus any gap between prior close and today's low or high) is say 83 points, then the stop may be set at perhaps 120% of that range or about 100 points. In the Deutsche Mark that equals $1,250.00 stop, plus any slippage that occurs.

b. Another method is placing a stop-loss just under the last swing-low or pivot-low. Note: A swing-low is a low point with higher prices on each side. For example, if last swing-low was at 7650 and price moves up for a few days to say 7750, then triggers a buy signal, stop may be placed just under the low price of the low day, perhaps at 7649.

That also represents a risk of over 100 points ($1,250.00+). Of course, the reverse is applicable on a sell, with the stop being just above swing-high.

c. Use a moving average penetration as a stop, i.e., place a stop on a long trade at just under a simple moving average, perhaps a nine-day average. The trouble here is that if we entered long at about 7750, by the time the moving average is penetrated by the price, the moving average may be well below the market (due to its inherent lag-time), at 7600 or so. That results in a stop-loss at 7599 stop, and a risk of about $1,900.00.

d. Still another approach is to place a stop under last week's lowest price. This method may be even riskier because last week's low may be 7550. That requires a stop of 7549 or lower, and a risk in excess of 200 points or over $2,500.00.

e. Another simple and a totally unscientific approach is known as a "money stop." It involves setting an usually arbitrary stop based on either the maximum money you wish to lose, or stop based on a reasonable sounding number of points or dollars.

For example, psychologically you may not want to lose more than $1,000.00, so you set your stop at a price equaling $1,000.00 loss potential. That number is arbitrary, so it may turn out to be either too small or too large, depending on the volatility and the market involved. For example, perhaps it's too small a stop for T-Bonds when they're volatile, or too large when they are dull. If using the $1,000 stop-loss in the Corn market or another low-risk low volatility market, it may be too large a stop to use.

Q. Is there a better way to set stops scientifically and more accurately, thus enabling me to keep risk low and still avoid getting "stopped-out" needlessly and stay in the potential winning trade?

A. Yes! By using "Drawdown Minimizer Logic." Drawdown Minimizer Logic is an amazing way to set stop-loss levels very tightly to guard against large losses, yet keep the stop scientifically and strategically placed just far enough away to prevent premature hitting of the stop-loss; thus keeping you in most trades.

Don't worry if this methodology seems too technical, because it's really much more simple than it first appears to be.

"D.M.L." is based on the maximum adverse movement (excursion) of past winning trades. For example, review the last "X" number of back-tested profitable trades and determine the adverse negative excursion incurred on each trade.

The idea is to look at the smallest stop-loss orders that would have kept us in at least 80% of the past back-tested winning trades. The worst 15% of those back-tested winners are eliminated from consideration.

Another important consideration is to review a sufficient sample of trades for statistical validity. According to statistical research by mathematicians, 30 samples are considered an optimum number to review. However, depending on your trading system's frequency, 30 past back-tested trades may take too long a period to test properly or reflect recent volatility.

Therefore, it may be best to work with a minimum number of 10 to 15 past trades. Ten to 15 back-tested trades should work well, but 30 trades are still considered an optimum number to use. However, if it's not practical to use 30 trades, you should at an absolute minimum use 10 trades to calculate the maximum adverse excursions. That way the numbers are still fairly valid from a statistical sampling standpoint.

If the past adverse excursions of those 80% trades went NO MORE than 15 Points negative before eventually being closed out at a profit, we can subsequently set our stop-loss at 16 points. Scientifically we should be able to stay in the vast majority of eventual profitable trades, yet have low-risk by risking only 16 points per trade.

Back-tested closed losing trades are not calculated, because with this amazing technique we only care about winning trade stop levels, not losing trades. The losing trades, of course will have potentially much larger adverse movements. By scientifically using the winners to calculate stop levels, we also take care of the losers by sharply reducing the losing trade stops.

"Drawdown Minimizer Logic" © will sharply reduce your risk level and drawdown potential. It's a proven and scientific way to drastically reduce risk without significantly harming overall profits.

This amazing loss reduction technique will allow comparatively small stop-losses, so your losses are small but still allow for consistent good size winning trades and possibly make lots of money with sharply reduced risk.

It's extremely effective in sharply lowering risk, but still keeping you in winning trades. Surprisingly, few traders use or have heard about this amazing technique, because it's rarely publicized due to the fact large successful traders want to keep it secret.

Many successful large traders use "D.M.L." as the most important ingredient in their trading. "D.M.L." may be the primary reason for their great success!

© Copyright 1997-2010 by Webtrading.com All Rights Reserved.