Drawdown is the term used to describe the process of losing money while playing a game. Losses in the foreign exchange market are unavoidable and will happen to every one of us at some point; the question is, what is the actual cost when you suffer a loss? If you have a significant downturn, you will need significant profits to return to where you began. I will show you a graph in this video highlighting the harm that may be caused by excessive drawdown.
The failure of many forex traders to comprehend the impact that an unchecked losing streak may have on their trading accounts is the most common instance of gross underestimating that these traders engage in.
When a trader loses, their money is taken out of their trading account. We’ve all been in that situation. Extremely improbable that there won’t be any further losses in the future.
Drawdown: What is it?
Drawdown is the difference between the highest value and following lowest value in the balance of your trading account. It is measured from highest value to lowest value. This displays the total amount of money you have lost due to unsuccessful deals.
To put it another way, if you build up your account to $100,000 and then suffer a loss of $30,000, your drawdown is 30 percent.
How might a drawdown affect your account?
Most people are unaware of this fact; nonetheless, in addition to the money that is lost, the drawdown may do a great deal of other harm to the account.
Example: Let’s consider two dim performances on an equity curve. Trader A and trader B.
Both have set their sights on achieving an annual growth rate of 5% over the following ten years. The horizontal axis of the graph below represents the passage of time in years, while the vertical axis represents the percentage increase or growth that occurred during this period.
Both achieved the goal of 5 percent growth throughout the program’s first year. During the second year of the trading operation, trader B has a losing spell that leads to a loss of 24 percent.
For trader B to attain the same aim as trader A, who in this example has a gain of 63 percent over ten years, he will need to make twice the first intended amount of 5 percent for each of the next eight years. Therefore, to make up for the previous year’s loss, he has to increase his annual profit by 10%.
If you have a drawdown of 10 percent, you need to increase by 11.1 percent merely to be even. If you suffered a loss of 25 percent, then you will need to achieve a gain of 33 percent to return to where you were before. And if you have a drawdown of sixty percent, you need a gain of one hundred fifty percent merely to return to where you started.
What can be done to control drawdown?
Drawdown is an essential component of trading; every trader will experience it at some point. However, what is essential to understand is how you need to perform following the drawdown phase.
Trading with a lower risk percentage might be one approach to avoid a drawdown of these disastrous proportions. If you have a strategy that has been back-tested and shown to have a positive expectation, then you should understand how the future downturn may affect your equity curve moving ahead.
To retain one’s discipline and keep one’s emotions under control during downturn times, it is preferable to reduce one’s level of risk and maybe even quit trading for a while. You may establish a weekly or monthly cap just as you can set a limit for each deal you make. If you lose more than 5 percent of the total value of your account, you will be required to refrain from trading for a certain amount of time.
If you don’t have a clearly defined strategy, you can feel motivated to use more leverage to recoup some of your losses. Don’t make this mistake. Get up and go away from the charts; give yourself a rest instead.
When trading the markets, you should constantly remember this rule in the back of your mind. The most important foreign exchange rule is to always protect your money.