Drawdowns in trading why and what to do

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The Meaning of Drawdown in Forex

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When it comes to forex trading, drawdown refers to the difference between a high point in the balance of your trading account and the next low point of your account’s balance. The difference in your balance reflects lost capital due to losing trades.

When you lose money on trades, you have what is known as a drawdown. As an example, say that your currency trading account begins with a balance of $100,000. You work your trading system, and after a bad trade, you see your account’s equity drop down to $95,000. Your account has experienced a $5,000 drawdown.

What You Can Learn From a Drawdown

Drawdowns also describe the likely survivability of your system over the long run. A large drawdown puts an investor in an untenable position.

Consider this: A client who endures a 50% drawdown has a large task and a real challenge ahead of him because he must have a 100% return on his reduced capital stake just to break even on the reduced equity position.

Many investors or fund managers on Wall Street are ecstatic, with around 20% profit for the year. As you can imagine, when a trader suffers a drawdown, he’s best served by implementing good risk-management procedures and readjusting his system as opposed to trying to trade his way back to the breakeven point aggressively.

Typically, a trader’s aggressive approach to get his capital back to break even will have the opposite result. Why? He will most likely become emotional, using leverage and over-trading to get his trading account back to even.

Too Much Leverage

When traders use too much leverage, one bad trade can have disastrous effects—and it often does. In short, traders are either too aggressive or too confident, and this leads to large losses or an unwillingness to accept a trade that is a loser and should be cut. There is an adage in trading that one trade will rarely make your trading career, but one bad trade can certainly end your career.

“What I Learned Losing $1,000,000” by Jim Paul and Brian Moynihan offers some excellent insight if you’d like to read a book that describes the emotional toll of drawdowns.

The book discusses how, by taking a large drawdown, a trader lost his career, significant amounts of his family’s fortune, and money belonging to his friends.

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The book also shares several tips on how to overcome common pitfalls of trading, such as implementing a trading plan that is likely to be emotionally driven instead of risk-management-driven.

The Takeaway

One of the most important and useful tips is to set a predetermined stop-loss point for your trade before entering. This will limit the amount of any drawdown you will take. Avoid making trading decisions based on emotion and, instead, focus on a strategy based on managing risk by exiting trades early enough to minimize your losses.

Once you take these steps, you’ll be able to stand back after you’ve entered a trade, knowing that you’re out of it with no questions asked when and if your stop-loss level is hit.

A lot of traders make the mistake of trying to negotiate with the market as to whether they should stay in a losing trade. This is a mistake because you’ll be making your trading decisions based on emotion instead of strategy, and you may do the thing that is the least painful at the time, but not necessarily more beneficial down the road.

Drawdowns in trading: why and what to do?

Drawdowns in trading are an integral part of the trading process, which is of great concern to traders, especially beginners. The fact that trade with 100% profit does not exist. Losses, like profits, accompany everyone, even the most experienced. Moreover, drawdowns are considered a very normal part of trades of each trader. Some people accept this pattern, and some are indignant about this. As a result, traders lose big ones under the influence of emotions. Actually, that’s why, it’s worth mentioning the topic of drawdowns and how a trader should behave.

Reasons for drawdowns in trading:

– The most common reason for drawdowns in trading is the psychology of trading. Often it is the emotional state that provokes the emergence of drawdowns, or rather, how well a trader is able to cope with emotions. The result will be influenced by gambling, greed, the desire to raise rates and win back losses. First of all, a trader must learn to control himself and fight when such feelings arise. Otherwise, he himself will lead to a drawdown.

– Lack of a functioning trading system or effective entry rules. This is the second main reason that leads the trader to drawdowns. Of course, intuitive trading takes place, but only if it is based on many years of experience of trial, error and victory. Relying on luck and intuition is not 100% here. As practice shows, this is not followed by everyone, especially novice traders. Beginners are better at picking up a trading strategy, trying to deal with it and gradually apply it to trading. They need to approach the issue of discipline especially well. Otherwise, it will be impossible to avoid drawdowns.

– Market changes are one of the most important reasons for the appearance of drawdowns. The nature of the market is often volatile and unpredictable. I have a working strategy you can not discount the volatility of the market. Even having positive results for a long time, drawdowns are not excluded. They appear as a result of changes in the market and, as a result, inefficiency of the trading strategy. All this means that the trader needs to correct the chosen strategy, given the very changes in the market that led to the drawdowns. Nothing wrong with that. After all, this is a completely natural situation – if the market has changed then the strategy of trade should change.

But, as we have already mentioned, the appearance of drawdowns is a normal phenomenon, which can be prevented by risk management, which can’t be said about their aggravation. Because, this is due to the loss of self-discipline, control over emotions and the emergence of a desire to recoup. It is always important to cope with your emotions in time and remember that there is no trading without any drawdowns.

Recommendations for drawdowns in trading:

First understanding that the magic method does not exist here. Each individual case has a separate exit path, since each trader is individual. But like the main reasons for drawdowns in trading, there are three councils.

– We work on our emotionality and reactions to drawdowns. A great way here will be to take a time-out and rest your brains from trading. Break, it will perfectly help to bring emotions in order. Understand, you will not miss anything in a few hours, which is quite enough to cool down. After all, you are still waiting for a lot of superb opportunities, and missing one or two during the absence of nothing means. better to cope with the heat of passion than to lose all the money.

– Next, we are talking about self-discipline, which helps to develop the diary of a trader. Although this is trite, but really the most simple and effective way. After resting and coping with emotions, start recording deals and results. Here it will be possible to follow your mistakes. Here you can not be lazy, understand the game is worth the candle, and every carefully recorded transaction in the future will indicate the right path. Many people think that this is a waste of time and they do not need a diary at all. He is not at all like that, because even masters of trading keep their diaries for years. It is especially important to keep a diary when the trader buries deeper and deeper into a drawdown.

– The question regarding the psychology of the trader, dictates a not quite standard, but effective method – the physical load. This is an excellent method to lower steam. Try physical exercises in response to every oversight or loss. Some just have a few squats or push-ups to release all negative emotions and thoughts. Thus, the trader takes himself out of the stressful state. even those who for various reasons do not have the opportunity to engage in physical activities, can try respiratory equipment. The main thing is always to start trading with a cold head.

Therefore, remember discipline and perseverance. Develop your willpower, overcome yourself, learn to self-control!

“General Risk Warning: Binary options and cryptocurrency trading carry a high level of risk and can result in the loss of all your funds.”

Drawdown and Maximum Drawdown Explained

So we know that risk management will make us money in the long run, but now we’d like to show you the other side of things.

What would happen if you didn’t use risk management rules?

Let’s say you have a $100,000 and you lose $50,000. What percentage of your account have you lost?

The answer is 50%.

This is what traders call a drawdown.

This is normally calculated by getting the difference between a relative peak in capital minus a relative trough.

Traders normally note this down as a percentage of their trading account.

Losing Streak

In trading, we are always looking for an EDGE. That is the whole reason why traders develop systems.

A trading system that is 70% profitable sounds like a very good edge to have. But just because your trading system is 70% profitable, does that mean for every 100 trades you make, you will win 7 out of every 10?

Not necessarily! How do you know which 70 out of those 100 trades will be winners?

The answer is that you don’t. You could lose the first 30 trades in a row and win the remaining 70.

This is why risk management is so important. No matter what system you use, you will eventually have a losing streak.

Even professional poker players who make their living through poker go through horrible losing streaks, and yet they still end up profitable.

The reason is that the good poker players practice risk management because they know that they will not win every tournament they play.

Instead, they only risk a small percentage of their total bankroll so that they can survive those losing streaks.

This is what you must do as a trader.

Drawdowns are part of trading.

The key to being a successful forex trader is coming up with trading plan that enables you to withstand these periods of large losses. And part of your trading plan is having risk management rules in place.

Remember that if you practice strict money management rules, you will become the casino and in the long run, “you will always win.”

In the next section, we will illustrate what happens when you use proper risk management and when you don’t.

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