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Drawdown forex: what it is and how it works

Large profits always involve high risks. Therefore, in addition to profit, traders need to pay attention to risk control and capital management. An important criterion for measuring this level of risk is withdrawal. So what is a forex drawdown? What is the best withdrawal rate?

What is forex drawdown?

Forex drawdown decreases an investment account from its peak to its minimum over a certain period. The drawdown is usually referred to as a percentage of the previous capital.

The formula for calculating the drawdown = the amount of capital that fell the most in the period ( = capital fund – peak capital) / the amount of money invested at the peak of the period.

Example of drawdown:

The trader deposits 10,000 USD into the forex account. After trading, the trader grows this capital to 16,000 USD, then loses again at 8,000 USD. Finally, the trader ended the year at $12,000 in the capital. Thus, the maximum capital of the trader is 16,000, and the lowest capital is 8,000. So the reduced amount of money in the trader’s account is 16,000 – 8,000 = $8,000. The drawdown ratio is 8,000 / 16,000 = 50%.

How is forex drawdown important?

Transactions always have a drawdown (referred to as DD). No one doesn’t have a drawdown. Since loss is always part of the investment, traders need to keep it under control. The drawdown is as low as possible.

A trading system that has done backtesting in the past and produced good returns is not everything. Traders need to pay attention to the withdrawal rate. If the drawdown is too large, the risk is high.

In forex trading, monitoring drawdown indicators helps to manage capital and manage risks effectively. If the account has a low drawdown ratio, the trading system works well and is stable over the long term. At that time, the trader must maintain the profit rate for each trade. In contrast, a high drawdown ratio indicates a high-risk trading strategy. At this point, traders need to adapt their trading strategies to limit the decline and preserve capital.

In addition, the withdrawal rate is also one of the essential criteria when choosing automated trading robots or copy trading accounts.

Suppose a trader wants to buy or use an automated trading robot, a forex signal, in addition to the profit margin, drawdown is a criterion not to be missed. An EA has an average return of 30% per month, but a relative Drawdown is up to 65%. This EA has a relatively high level of risk and traders should not choose.

Similarly, when choosing a copy trading account, in addition to considering the profit, the trader must also check the withdrawal rate.

What are the types of drawdowns in forex?

Drawdown is the loss of capital in a particular investment period, but drawdown has three different calculation methods. In addition, each type of drawdown represents a distinct sense of trading account risk.

Drawdown is of three types: Absolute Drawdown, Maximal Drawdown and Relative Drawdown.

Absolute Drawdown: This is the decrease of the account from the initial capital to the lowest fund. This indicator is measured by the total loss (USD). The Absolute Drawdown value changes when the balance of the account that makes the fund is less than the previous minimum. This indicator represents the highest amount of capital loss from account deposit at the present time. The higher the Absolute Drawdown, the more it shows that the trader is losing more of the initial capital.

The maximum drawdown is the decrease of the account from the highest capital peak of the performance to the lowest capital minimum. The maximum drawdown represents the highest account loss result during the entire trading process, showing a higher level of risk than the absolute Drawdown.

The relative drawdown is the maximum drawdown calculated as a percentage. Relative drawdown = Maximum drawdown / The highest peak of capital. Relative drawdown is a percentage, so it is easier for traders to know the level of risk than to look at a specific number of Maximum Drawdowns.

What is the best drawdown?

Among the drawdown indicators, the Maximum Drawdown or Relative Drawdown is the most important, which clearly shows the maximum drawdown of an account and its riskiness. So how much Massimo Drawdown is the best?

The most correct answer is: the lower the maximum Drawdown, the better, the lower the risk.

However, forex trading is not always profitable, losses are certain to happen. Therefore, even as a professional trader, their maximum Drawdown should still be a ratio of more than 0%.

There is no standard ratio to determine the account with a good drawdown. But usually, experts take the 20% mark to assess how risky an account is. This means that your trading system must ensure that the maximum Drawdown does not exceed 20%.

Assuming you lose 20%, you need to make a 25% profit on the remaining capital to return to the original capital. If you lose 50%, you have to win 100% on the remaining capital to return to the original capital and if you lose up to 80%, the win rate required to return to the original capital will now be 400%. The higher the maximum Drawdown, the harder it is to reach a draw.

How to check the drawdown?

In forex trading, the psychology of trading is an essential factor. It can disrupt any trader’s trading plan. Therefore, to achieve a low withdrawal rate, traders need to check their trading psychology well.

Limit a maximum drawdown for the account.

The maximum withdrawal limit is no more than 20%. Some people choose the rate of 20%, but others choose 15%. In addition, traders must set limits for a specific period of time. For example 1 week, 1 month or 1 quarter…

A trader makes a maximum withdrawal of rules of no more than 20% for a month. If this ratio exceeds 20%, the trader no longer trades. Next, traders need to review their trading system or capital management strategies and start with a new system in the following month.

Lowest loss limit per trade.

One of the rules that traders can apply to limit the loss of each order to only 1-1.5% of the total available capital of the account. With this principle, if the trader loses ten consecutive orders, the account will lose only 10-15%. If you lose 20 orders in a row, the account loses 20-30%, the chance to recover at break-even is possible.

To apply this principle, traders must adhere to an average leverage ratio, combine a low trading volume and set the stop loss on all orders.

In addition, if the trader loses continuously, the trader should reduce the loss limit, corresponding to the current capital. Suppose the trader initially limits the loss of each order to 2%, then loses 10 consecutive orders, the account loses 20% of the capital. At this point, the trader should reduce the loss rate to 1.5% or 1%, this strategy will help the withdrawal rate not to increase too quickly.

However, if the number of consecutive losing orders is more than 30% or the drawdown has exceeded the allowed limit, the trader should stop.

conclusion

Drawdown is very important in capital management, in risk management. In order for traders to be profitable in the long term, you need to have a good trading strategy and effective risk management. Keeping track of the withdrawal rate of trader accounts is easy, but how do traders keep it under control? There are countless techniques, but the rule for traders to manage capital most effectively is discipline.

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