The following article is a re-post of Zulutrade's newsletter dated Jan. 4, 2012:
Dear Zulutraders,
After 4 years full of data analysis, we can now suggest a quick tutorial that will show you how to prevent, in most cases, a large Drawdown by a provider in your portfolio, and disable such providers before the drawdown gets serious.
We will base our tutorial on the Signal provider "FX178", a signal provider that quickly climbed at the top 10 performance list, but suddenly got hit by a huge drawdown. How could we prevent this drawdown and what could we do to detect that something is not right?
Below we can all see the tragedy:
Now let's see how we could detect it. At the chart below we can see the weekly Worst trade. As you can see this provider's strategy has never crossed the 170 pips worst trade limit for the first 6 months. Right after that he Started Risking more, his Worst Trades grew larger and his appetite for risk became stronger; he also started risking 200 pips or more, in contrast with the last 6 months when he never did so. It is obvious that he changed strategy. If you could have placed a stop loss equal with the average of the worst trades he had experienced during the last 6 months, you would have prevented the whole tragedy afterwords.
This practice will not work for Signal Providers with tight stop losses such as i.e. Forextechno [EURUSD_LT]. It will only work, in most cases, with signal providers that will experience a higher than usual drawdown, putting our accounts in risk.
One of the best ways to spot the right stop loss, (we always recommend to use a stop loss as a safety net by selecting the Safe option at your accounts Advanced Settings), is to use our latest backtest tool seen below. You can find it in your Settings page, after you login, at the button "Backtest"
Find the right stop loss for each one of your providers, or decide to remove the provider, in case there is no stop loss that will make his/her strategy viable. Try before you buy!
Play with slippage and see if this strategy is viable in real life (unless the provider broadcasts from a live account, in which case all results are perfectly realistic).
