One of the main terms in Forex trading is the drawdown. A lot of traders include this parameter to perform better, and improve their trading strategy.
Let’s see in this article what a drawdown in Forex is, how it is calculated and how it can influence a trading strategy.
Meaning Drawdown Forex
The drawdown in forex is the capital reduction that a trader has after a series of losses.
Every trader, during his trading activity, has some losses and some winnings.
What is important to analyze, is how much those losses reduce the capital.
In order to do that a monthly analysis of the trading statement is essential.
Usually a drawdown is between the 20% to the 40%. Above the 40% it means that there are some issues with the trading strategy used.
To calculate the drawdown, it’s necessary to take the highest pick before the losses and calculate the difference with the first lowest one after it.
If a trader reached the maximum amount of $10.000 in the account, and afterwards he had a series of losses until touching the $8.000, it means that the drawdown is the 20%.
$10.000 – $8.000 = $ 2.000
Drawdown= (2.000 * 100)/10.000 = 20%
This is the formula to use for the calculation.
When in one month there is an important drawdown, it means the trading strategy should be reviewed.
Trading Strategy – Drawdown forex
When talking about the trading strategy to review in order to reduce the drawdown, specifically a trader should analyse his money management.
The money management represents the amount of money to use in each trade to avoid complete capital losses.
The rule is that for each position, a trader should risk maximum the 5% – 10% of his capital.
This means that with an account of $10.000, for each trade the user should invest and risk maximum $500.
Following this strategy help traders to minimize the risk involved in trading and also the drawdown in forex.
Following this example we should say how to trade with different positions.
For instance, if a trader wants to open 3 positions, he should divide the risk between these 3 positions.
Taking again the account with $10.000 and risking the 5%, the $500 should be divided in the 3 trades, so for each position the trader should invest $166.67.
Following this strategy, the risk is under control, and adding the trades’ diversification helps to risk even less and help to avoid a big drawdown.
Conclusion Drawdown Forex
At the end of this article, hopefully it’s clear what is the meaning of drawdown in Forex.
The worst drawdown that a trader can have is the 100%, because it means the trader lost all his profit made in the past.
Generally all traders can face a drawdown, the average is between the 30% to 40%.
To avoid big losses is essential to have a good trading strategy, or mainly a good money management as explained above.
The psychological aspect is also very important, but when a stop loss has been set up, there is no need to worry about losing all the capital in the account.