Each trader wants to win the race for profit in the trading world all the time. How do you feel when after getting many successes you have to face hurdles and losses continuously? No doubt it’s a very disappointing situation for a trader who likes to win all trades.
Here it’s important to know about drawdown and how do you manage it by trading plans? At first, you must be curious to know: What is drawdown in forex?
In economics, there are many definitions of drawdown. If we talk about forex, here drawdown shows the depletion of equity of a trader’s portfolio or trading account. Drawdown appears in your trading activities when your investment goes down and reduces gradually.
In forex trading, drawdown also shows the difference between high and low point balance in a trading account. A loss in trading activities is another name for drawdown. It happens mostly because of traders’ aggressive reactions and emotional decisions.
Let’s read this post to get more information about the forex drawdown!
What Is Drawdown In Forex
At the time when you enter the forex trading market, you will explore more complications with the passage of time. The drawdown is one of these issues that every trader faces while trading.
Let’s see What is drawdown in forex?
Simply, drawdown is a stage that shows the differences between high point and low point trading account balances. Here these differences tell a trader how much he loses in losing trades.
A trader can use drawdown in forex trading for a single position. At that stage, the drawdown appears when the buy-sell price goes down from the entry price. It is also used to calculate the validity of a trader’s portfolio.
In this way, you can gather winning and losing points at one place that will show you the range of balance at the lowest point where it hits.
Three Types Of Drawdown
All trading strategies in forex trading work according to your measurements and calculations. That’s why it is essential to make your calculations accurate. There are many types of drawdowns that play an important role in your trading plans.
Three main types of drawdown are listed below:
● Relative Drawdown
Are you a math lover? Do you like equations? If yes, then there is a lot of fun and excitement for you. Basically, relative drawdown is the percentage of maximum drawdown. Mostly, the percentage of your trading account portfolio is defined by drawdown.
For relative drawdown, you can calculate it by dividing the maximum drawdown by its peak and then multiplying it by one hundred. The equation can be written as:
Relative Drawdown= MDD/MPx100
Let’s understand it by an example!
For example, you have $30,000 as maximum drawdown(MDD) $40,000 as maximum peak(MP). Now solve it by putting in the above equation.
It means you have a 75% drawdown against the value of your portfolio.
● Maximum Drawdown
It is very similar to relative drawdown. Here you have to calculate your losses with the help of equity peak instead of early-down payments. Additionally, it is also used to measure the distance between the highest and lowest equity values of a trading account. That shows the whole trading account duration.
Let’s take the same example used in relative drawdown and try to understand it.
The equation for maximum drawdown is
MDD= Maximum Peak – Minimal Equity
Now solve the equation by taking values maximum peak as $50,000 and minimal equity as $20,000.
MDD= 50,000 – 20,000
It is theoretical because here you calculate the highest value at a specific point. It means that the loss is compared to the possible amount that you would have, not to the actual amount that you have.
● Absolute Drawdown
In absolute drawdown, you can check the relation of a big loss to early installment. A trader can discuss absolute drawdown in forex trading when the value of the account goes below the opening down payments.
At this level, you can find the difference between account equity and starting installments. Absolute drawdown is also a reference point for early investments. For example, if the deposit value is $40,000 then your portfolio increases and becomes $50,000. It is known as the equity peak.
Similarly, the value of the portfolio decreases and you will get $30,000 as minimal equity which is the lowest point.
The equation of absolute drawdown is:
Absolute Drawdown= Initial deposit – Minimal equity
Now put the above values in it.
Absolute drawdown= 40,000 – 30,000
Absolute drawdown= 10,000
Your absolute drawdown is $10,000
5 Easy Steps To Control Drawdown
It is a fact that every trader has to face a drawdown while trading in the forex market. The need is to control it wisely and without failure. Not everyone is capable of doing so. Your reaction after losing money describes the type of trader you have.
The main thing that you have to note is that you have to save your account from crashing while facing drawdown. There are 5 easy steps that will help you to come over the situation of drawdown.
Step 1: Command your Emotions
It is not easy to keep your emotions in your command or under control. Once you control your emotions, you will easily make wise decisions. So, be careful and don’t be prey to your emotions.
It is difficult for those who are facing continuous losses. Emotions of fear and anger are responsible for risk in trades. Let me tell you how you control your emotions. Just be calm and take a deep breath to make your mind relax. Take a bath and go outside for a long walk. Read some informative articles or a book.
Stop trading until you will be able to trade without any fear.
Step 2: Lower The Value Of Risk
A drawdown helps a trader to observe the risk ratio that appears around the portfolio. No trader wants to face losses in trades but it happens to many of them who suffer continuous losses at any stage.
That’s why a trader must make a trading account that can hold on to losses and downturns. It is your own decision to show your risk tolerance which means you can decide on low risk while trading. The level of risk in trading depends upon the value of your account or portfolio. It may be increased or decreased in different trades you select.
Step 3: Reduce Risk In Continuous Losses
It is seen that many traders have to face losses continuously that break their courage and they lose heart. So they want to reduce their losses by increasing risk. For this, they also take on careless capital of leverages to get started from the beginning.
If you are getting losses, again and again, in trades, experts advise you to lower your risk as much as you can. It will also save your portfolio. After stopping losses you can return risk again with each trade.
Step 4: Set A Drawdown Cap
If you want to avoid burn, crashes, and losses in your trading account, fixing a drawdown cap is best for this purpose. It means you have to stop trading for some time if you beat a drawdown at least for one month.
You have to wait until the drawdown reaches your desired percentage of risk. For this, you must stick to your work to maintain your position. For better results, you can change your trading plans from month to week.
No doubt, it is difficult to come out of a critical situation but it may be possible by getting high-risk trades. A little pause is essential for achievement.
Step 5: Take A Break
If there is no way to handle the situation, it’s best to take a break and set aside some time until the situation will come into your control. It is the time you have to stop trading and wait for the time when everything becomes better.
I know it’s not easy to leave your position but you have to do it for the best position in a trading platform. It will save your portfolio from becoming worse and stop you from making your trades in the wrong way. This is the final step when there is nothing in your favor.
Stop trading and leave the market for some time and come back with more effort and plans.
What is a good drawdown in forex?
It is recommended by experts to keep the drawdown level below 20%. At this level, investors or traders can trade successfully with calm and free of tension. It will save their capital and help them to make good decisions.
Is drawdown normal for forex?
Normally, our trading accounts collect a drawdown. If we can’t avoid drawdown, we should know how to control it. At that stage, money management plans help traders to recover large drawdowns and step forward.
What is the maximum drawdown?
Maximum drawdown(MDD) is maximum loss from a peak to the portfolio. It is done before the achievement of a new peak. MDD is a type of indicator that is used in downside risk during a specific time period.
Finally, you are now fully aware of Forex Drawdown in detail. It is very complicated to understand the forex trading market so deeply. We have tried our best to clear every single point in detail.
It is essential for traders to set stop losses that will help them to limit the price of drawdown. It is also important to take decisions without the interference of emotions. As emotional decisions will lead you toward loss.
After following the above mentioned easy steps, you can easily get a perfect entry in the forex trading market and will be able to achieve a lot of rewards. For a successful trader, it is crucial to control drawdown to get success and make money.