ForexSpirit

No clear trend direction in EUR/USD today. It was a bit all over the map really.

My thoughts on how to alter my position sizing based on being in a drawdown situation relate to the rate of recovery table that you’ll often find mentioned in trading circles.

The concept is simple and straightforward: the percentage gain it takes to recover from a loss increases geometrically based on those losses.

I’m sure just about everyone who has dabbled in trading has come across this information but I doubt all that many really ponder on the wisdom it contains.

Displaying the above concept in numerical format is done as follows:

If you experience a drawdown of 10% then you need to make a return of 11.1% on your remaining capital just to get back to where you started from.

If your drawdown is 20% then the recovery return bumps up to 25%. If you’re unlucky enough to be down 50% then you’ll need to double your remaining capital to claw your way back (a 100% recovery return).

If you succumb to a 90% drawdown then you’re looking at a monumental 900% recovery return.

The obvious mantra to be extracted from this information is that you should keep your losses and drawdowns relatively small. This allows you the greatest opportunity to make those losses back in a reasonable timeframe without having to resort to drastic measures.

My scalping approach is setup to allow for infrequent but relatively large losses (in the region of 7 to 10%). What I am contemplating is increasing my gearing for new trades if I am holding an open trade that is significantly in the hole as well as during an active drawdown period.

In the red

Increasing the gearing on new trades while an open trade is under water is a twist on the rescue concept that fti favours. The standard rescue method advocated by fti is primarily an aggressive way to average down price so that you are able to extract yourself from the market at breakeven on a much smaller price movement in your chosen direction than was previously necessary.

My reasoning for doubling, for example, the gearing on ‘rescue’ scalps is that it would provide an increased equity buffer if the failing trade reaches its stop loss level.

If the ‘rescue’ scalp is unsuccessful and in turn becomes stranded then, by the rules of my scalping method, I will have reduced the possible leeway that price has available to meander before reaching a point where I must close out all trades for a 7% loss across all open trades. I will have brought the catastrophic stop loss level when all trades must be closed out closer due to the increased size of the rescue trade than if I had used the same gearing as the original trade.

Drawdown recovery

Let’s say a loss is booked and the account enters a drawdown phase. There are obviously pros and cons of increasing gearing for new trades in such circumstances.

The main positive benefit is that successful trades that use higher gearing will accelerate the process of recovery.

The primary disadvantage is that higher geared trades have less wiggle room and thus there is a higher risk of wrongly timed trades needing to be closed out for a loss. While a normally geared trade might have a stop loss level of 250 pips away from the entry point, a trade that uses twice the gearing will only have 125 pips to manoeuvre in awaiting the chosen trend direction to assert itself.

Stay flexible

I keep coming back to the flexibility mantra espoused by fti. I don’t currently see a huge benefit to rigidly mandating that I should increase the gearing of my trades in any or all of the above examples.

What I am veering towards is to allow myself the option of increasing the gearing of my trades as circumstances dictate. I want to be as flexible as possible.

Sometimes I might deem it best to double up my gearing on a new trade even though I have one already underwater. Other times I’ll just stick to my standard lot size.

When clawing back from a drawdown I might see a high probability opportunity that warrants increasing my gearing but it probably won’t be the defacto size during the climb back to a new high watermark for my account.

Total daily pips: 48