Achieve a 1 percent Forex Drawdown all your EA trading and Forex techniques

Achieve a 1 percent Forex Drawdown all your EA trading and Forex techniques

Many Forex Traders regard drawdowns as an important statistic when trading or testing an Expert Advisory.  We often hear traders saying that the drawdown on this system or EA is unacceptable.

What is a drawdown?

A drawdown is basically a loss period experienced by a trader or investor. The drawdown is normally measured in $.

Forex Draw down relative to what?

Many don’t realise that the term or phase drawdown can not and should not be used on its own. Saying a drawdown is $200 does not tell the investor or trader anything. It is like saying the temperature is bad. You need to know what the person is comparing the temperature to – for cooking an egg or for swimming in a pool – to give it meaning.

So phases or terms  such as the drawdown relative to the account size, or gains are more important.  A $1000 drawdown might look bad on its own (according to you) .  But if you learn that the drawdown is relative to a gain of $100 000, suddenly the drawdown does not appear to be that big. Or an investor would think that a drawdown of $1 000 is very small if a $100 000 trading account was used.

To give the term drawdown any  value one should always compare the drawdown to something else. A very common comparison that happen without traders being aware of it is the drawdown compared to account size.  So traders would say something like “The drawdown is 60%”. What they are really meaning is that the drawdown (say $3 000) amount is 20% relative to the account size ($5 000).  Now is a 60% drawdown good or bad.

Most Forex Trader Broker accounts are under capitalised

It could merely mean that the trader is under capitalised. The trader has too little money in their account. So by merely increasing the account size to $300 000 suddenly the drawdown becomes 1%. So $3000 would be 1% of the trading account balance. One way of looking at drawdown is relative to account size. You can change the drawdown % by merely increasing or decreasing the account size. So now, is the 1% drawdown good or bad?

Are you comparing your Forex Draw down to gains made

Taking the previous example a bit further. Lets say the results generated by the $300 000 account  were $60 000. 20% return on capital. Suddenly a new comparison is possible. You can now compare the draw down to gains made. Suddenly gains are 20 times the drawdown or 2000% of the drawdown amount. Pretty good isn’t it.

Do Draw downs represent risk?

If you took drawdown as the risk you are taking then the result on risk would be 2000% in the above example. Also pretty good.

When testing a EA using a $ 10 000 account and encountering a $ 7 000 drawdown most traders will run for the hills. But lets say that drawdown generated gains of $70 000. Suddenly you return of your drawdowns (Risk) is 1000%. A great investment. All that has happened here is that the trading technique used was under capitalised (one of the main reasons why many commercial businesses fail). Maybe $70 000 should have been used and then the drawdown % would be 10% and the return 100%.

2 types of draw down

Also remember there are 2 types of drawdowns:-  The absolute drawdown and the Maximal drawdown.

The absolute drawdown is relative to the equity curve. In the example above the $ 7 000 drawdown may only have happened after $ 20 000 profits were made. The equity curve never went negative. So the absolute drawdown is 0 and the Maximal drawdown is likely to be $7000 or 10% of capital used.

Importance of timing

This brings into play timing. If the drawdown happened on the day the investment started the relative drawdown and the absolute drawdown would have been the same.

Achieve a 1 percent Forex Drawdown all your EA trading and Forex techniques

I hope this gives you a better feel of what drawdowns are all about and how they should be measured and interpreted. Many good trading system have been rejected because the trading account are under capitalised but good gains have been made.

Keep an open mind.

2 Comments

  • neil

    Reply Reply April 4, 2017

    This is of course great for those with capital, and obvious- but many people are not wealthy and CANNOT use such vast capital, have only small accounts.. just telling them they should have more capital is to say the least unhelpful …. please consider these people in your advise? thanks

    • Alex du Plooy

      Reply Reply April 5, 2017

      The amounts used are just examples – the same principles apply to small accounts using micro lots. However the biggest problem on under capitalisation occurs at this level.

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