Forex Drawdown of a trading system is defined as the distance between the maximum and the minimum in the equity of a period, ie it is the worst streak of losses from the last maximum until it is exceeded by the next maximum. It is very common to speak of the maximum or historical Drawdown that is the worst streak of losses occurred during the entire trading period.
It can also refer to a decrease in the balance of a trading account.
For example, if you have an account with 5000 USD and you lose 1000, your account will have 4000 having suffered a drawdown of 20%. Knowing the drawdown suffered in a trading account is an important part of controlling risk. Traders will normally have a maximum drawdown limit that they are willing to assume in their trading plan.
Let’s look at a small example in the currency pair EUR/USD:
In this price chart we see a considerable distance from point A (last maximum) to point B (minimum after the last maximum). That distance is the current drawdown. The next one begins when the next maximum is reached, in this case at the end of the graph.
Let’s see another example with current drawdown and maximum drawdown (historical for the given graph):
- Examples of current and maximum drawdown
Here we can see how C is the next maximum reached, so the new period starts counting from C until it reaches a minimum, D, and that value is maintained until the last maximum is exceeded. For this particular case, the Maximum Drawdown is C-D.
If you look at the end of the line of C you get a new maximum. There would begin to count the new Current Drawdown.
How is the drawdown measured?
Generally the drawdown is expressed in terms of percentage although it can also be expressed in quantities, and the order is important to measure the drawdown: the minimum must be after the maximum.
To exit the drawdown, the level of the last maximum must be recovered. This causes that when you look at your cequity curve there are two situations: You are at a new maximum, or you are going through a Forex drawdown.
In addition, you have to keep in mind that the profit necessary to recover from a drawdown is always a percentage higher than the loss suffered.
Keep trading when you are going through a drawdown requires that you have a lot of confidence in yourself and especially in your trading system. You need to know what you can expect and how good are your probabilities to recover. For this, you need to know how the drawdown occurred: is it composed of several consecutive losses or perhaps only a large loss is responsible? What percentage does it represent?
When you perform a backtest, the program usually informs you of the maximum drawdown of the system, number of losing trades, rdifferent performance rations, etc. If you trade manually, you can calculate the drawdown of your portfolio using Excel or any spreadsheet.
FOREX DRAWDOWN IS THE WORST STREAK OF LOSSES
The drawdown value is commonly used to measure the risk level that we have with a certain system since it indicates what margin we must have to be able to withstand that streak of losses.
This is why low drawdown systems are safer because the losing streaks are smaller and therefore we can invest with these systems without having large capital.