Drawdowns and maximum drawdowns.

Drawdowns in forex trading can be measured by taking the difference between the highest peak achieved on your account and the lowest trough before a new peak is obtained. It is known as the largest loss made from a trade or consecutive losses before making a profit.

For instance if you are holding an account of $100,000 and trade it to $120,000,  then to $60,000 and finally back to $100,000, you amount of drawdown would be ($120,000-$60,000) =$60,000.  This is equal to 50% drawdown. When you get a 50% drawdown, it requires you to make 100% wins on the current account balance to get back our account to break even.

Having a loss in forex trading is normal and at some point every trader experiences it, not once , twice but on several occasions. This is something you cannot avoid as long as you open a trade in the market because you will never be 100% sure of what is likely to happen in the market.

However much perfect your system may be, it can still cause drawdowns to your account. So seeing a drawdown on your account doesnot mean you are a poor trader or your system doesn’t perform however the size of the draw down matters.

Large drawdowns mostly happens in times when a trader forgets about their trading plan, or finds it hard to accept a loss on their accounts and as so they try as much as possible to  recover the lost money from their accounts.

They become so desperate and greedy and end up using big position sizes or leverage. This kind of habit is disastrous because during this time, a trader is always taken up by his or her emotions and only trades basing on those emotions which can easily wipe out the account.

These are some of the major causes of large drawdowns;

  • Poor or no risk management rules.
  • Greed.
  • Fear to lose money off your account ( Need to make back the lost money very quickly).
  • Wanting to revenge back on the market
  • Overtrading
  • Using too much leverage

Drawdowns may be aggregated consecutive losses on your account that may lead to a big loss or a sharp loss on a single trade. This may be 50% and above.

let’s take a look at another example below.

If you are holding an account of $ 10000, and you risk let’s say 20% of your money each trade you take.

That is (20%×10000) = $ 2000, only 3 losing trades are enough to put your account at stake (60% loss) and it will only take 5 consecutive losing trades to blow your account and you are out of the game.

From the figure above,

Drawdown= ($10,000 – $4000)/$10,000 = 0.6×100% = 60%

Despite having a drawdown on your account, your system should be able to give a positive result even at the periods of your worst peak.

When you trade with good risk management rules you are able to reduce on your drawdowns and have more profit compared to your losses. This can only be achieved by determining your stop loss points and appropriate position size before entering any trade. You will be able to limit the amount of drawdown in case the market doesnot go as expected.

Drawdowns can also be reduced by;

  • Avoid holding on losing trades for long
  • Do not risk much of your capital on just one trade . Risk at least 1-3% per trade with a realistic risk reward target and try to be consistent with your risk percentage.
  • Using a 2% rule risk management to trade
  • Do not fight with the market
  • Strictly follow your trading rules

Like we said before, a loss cannot be avoided as long as you are holding an open position in the forex market, but it can be limited. Aim at protecting your account from too much risk by using the predetermined stoploss and keep your risk as low as possible.

If you make consecutive drawdowns, consider revising your trading system and make adjustments if neccessary.

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