Q: I have just read the 2nd edition of "Trade your Way" and I still don't understand how maximum adverse excursion is determined. Is this an estimate of what earlier trades have done? How can you determine the MAE upon entering a trade when that trade obviously has no history? The way I read the explanation made it sound as if it was the maximum intraday excursion—does this change from day to day or what?
A: When the trade is over look at the maximum excursion against you. If the trade was always profitable, then it is zero, but when it becomes a loss, it is an adversion excurion. The maximum (expressed as an R-multiple) is the MAE.
Say you enter into a trade at 10 with a stop at 8. You never get stopped out and you eventually sell at a profit of $5. However, during the first two weeks of the trade, the price got as low at $8.50. Your MAE is $1.5. And since R = $2, the MAE is 0.75R.