Yes I’m going to be discussing some important forex trading analysis terms. Whether you have designed your own system or are looking to request the services of another it is important you know the MAE, MFE & Drawdown of the system/signal service.
What is MAE, MFE and Drawdown?
MAE = Maximum Adverse Excursion
It calculates the amount (in either pips or % movement) your trade moved against your position once it was opened until it was closed. As an example, if I have one trade opened at 1.2107, and it drops to 1.2095 then runs up to 1.2133 where I then exit at 1.2121 the MAE of this trade is the lowest price during the trade (1.2095) minus the opening price (1.2107), which equals (1.2095 - 1.2107) -12 pips (MAE figures should always be negative).
MFE = Maximum Favorable Excursion
It calculates the amount (in either pips or % movement) your trade moved in favor of your position once it was opened until it was closed. If we use our example above the MFE would be calculated as the highest price made during the trade (1.2133) minus the opening price (1.2107), which equals (1.2133 - 1.2107) +26 pips (MFE figures should always be positive).
Drawdown calculates the amount (in dollars or %) your system lost before it made a higher high on the equity curve. Drawdown derives from calculating the difference between the current equity value, and the highest equity value prior to the current trade, then, obtains the lowest drawdown figure. As shown in the following example in this table with trade #, equity at the end of the trade, and the first drawdown calculation as columns…
|1||$106,780||$106,780 - $110,000 = -$3,220|
|2||$103,890||$103,890 - $110,000 = -$6,110|
|3||$107,665||$107,665 - $110,000 = -$2,335|
|4||$112,932||$112,932 - $110,000 = +$2,932|
|5||$125,653||$125,653 - $112,932 = +$12,721|
|6||$113,675||$113,675 - $125,653 = -$11,978|
|7||$121,011||$121,011 - $125,653 = -$4,642|
|8||$137,457||$137,457 - $125,653 = +$11,804|
The drawdown therefore is the lowest number in the above calculations, which is
-$11,978 (drawdown is a negative number or 0 - if you’ve never had a losing trade), or expressed as a percentage which would be the drawdown divided by the maximum equity at the time of the drawdown, in this example it would be:
$$-//$11,978 / //$125,653 = -9.53//%$$
So what do all these numbers mean?
Whenever you encounter a system whether it be your own or somebody else’s you need to know these figures so that you can be comfortable with the results. With the MAE you need to understand that this will be the system’s stop loss point GENERALLY, if the system does not employ stops then the average MAE will give you an indication of how far the market moves against you - on average. If the average MAE is a distance away from the stop loss then you could reduce your stop loss to see if it enhances profits.
Conversely, if the system employs limit orders this will no doubt be around the MFE, if the system does not employ limit orders then the MFE will give you an indication of how good the system picks winners (obviously the larger the MFE the better it seems to pick large movements). If the average MFE is close to your limit price then extend your limit price out further to see if it enhances profits.
Lastly, the drawdown gives you an indication of how much the system can go against you.
It is better if the figure were in a % format as a dollar amount is useless unless you know what the maximum equity amount was prior to the dollar drawdown amount. Knowing this amount will give you an indication of your system’s risk. Ideally you would want a system that has a 3:1 reward to risk ratio, meaning the system’s net profit (in % or dollar) divided by the system’s drawdown (in % of dollar) should be 3 or more if you are looking for a viable system.
Some authors will state that 2:1 is sufficient, but look for system’s that generate more. Knowing this can help you ascertain the worth of any system.