There are many terms that will bring questions when first getting into forex. Doing your research is okay but sometimes you just need to dive into a demo account and start playing around. This will help you get your feet what and deal with things while they come up. Of course this is made easy with demo trading since the money is not live so you don’t lose anything you just learn. Don’t sit back and do to much research for that reason read this article and jump right after by setting up your demo trading account and hitting the buy/sell button so you can see drawdown in action.
So what is drawdown? Drawdown is the balance difference in your account from live trades. So if you have one trade open that is currently negative 40 pips for a total of -$40.00 USD that is a drawdown of $40.00 total.
A lot of old paradigm traders and even new traders like to see historic drawdowns over the course of a long time. This helps when trying to figure out the risk involved with a certain strategy or even an expert advisor (auto-trading bot).
You can even look back at this for your own trading there are indicators for MT4 (CHECK OUT OUR FREE INDICATORS PAGE HERE) that will show historic drawndown along with other useful information.
For me personally, I try not to have more than 6% risk involved with live trades. So this is either 3 active trades at 2% risk or 2 at 3% risk. When I am trading New Paradigm I am really only risking half of what my stop loss states since I manually get out of those trades before they turn to far against me and look for a re-entry. If you don’t understand what I am talking about you can make your way over to our New Paradigm Page.
When you are demoing you don’t really have to be concerned about drawdown. Especially in the beginning when you are trying to get your volume of trades in. I have heard of people taking 100-150 demo trades in one day WOW! I don’t think I could ever do that but I would love to take a day and try. But that drawdown would be very intense and too much to handle if that were live trading.
Once you get closer to going live with your trading strategy yes you need to make sure you are keeping your drawdown under control aka don’t overtrade. There are two levels of trading in my eyes when you are simply learning what not to do (not just trying to win) then when you get closer to going live trying to win and get your win percentage where it needs to be. There is no set time and all traders will be different depending on where they are in their mindset and the time they can apply to trading.
I personally did a week of demoing before going live but that was with old paradigm trading. I still demo from time to time with new paradigm trades as I am still learning from my mentor Steve Gregor and the rest of the veteran traders. I currently trade Harmonics, Pitchforks, Fibonacci Retracements and Channels live if they are energy points. Meaning they both line up at the same point.
Acceptable Maximum Drawdown
Maximum drawdowns will vary quite a bit from strategy to strategy and also Expert Advisor To Expert Advisor. For an Expert Advisor I wouldn’t want a drawdown more than 10-15% on average.
With that average, I am talking about over the course of 1,000’s of trades and years if possible. Because if you are only going off of 100’s of trades that same EA in another part of the year is probably going to vary drastically and maybe a lot worse or a lot better when it comes to drawdown. That is why I say 10-15% on average there will be times with an EA where it may be 25% or even 30% max but other times will be much less as well if it a reputable EA.
When it comes to trading strategies again this will vary quite a bit. I personally think of drawdown as Risk management and I never risk more then 3-4% per trade max. Then at any one time I never risk more than 6% total over all my trades. This is usually 2-3 trades max as well.
This makes it much easier when you think of risk and drawdown as a risk percentage then you never over leverage yourself. Set a cap and stick to it. Simple.
How Is Drawdown Calculated?
This is important to figure out as when you can calculate your drawdown you can tell exactly how much you are going to risk before a trade.
Drawdown is simply equals your entry minus how many pips you are negatives times your amount placed per pips.
Current Trade Drawdown => -Negative Pips X Lot Size per pip
So if you set your SL is -10 pips at 2% with a $100.00 USD account and you are trading EURUSD & 5 pips negative your drawdown is -$1.00 USD. Do you see how that works? Your total risk would be $2.00 per $100 and since you at 50% of your stop loss your drawdown would currently be at half that.
What Does Max Drawdown Mean?
Max Drawdown can mean a lot of things. Like I have mentioned previously there are indicators you can use with MT4 that show all these drawdowns as far as max and average. In any one trade this would be the max that you are in negative pips times your lot size of course.
For an EA this would be the max drawdown of the cumulative trades and the same goes for strategies as well. You can track these with indicators and EA’s itself that integrate with something like myfxbook.
Drawdown is something you need to look at with certain strategies and expert advisors. However when you first start demoing it shouldn’t matter just trade away when the entry criterias are met.
When you go live your number one priority is risk management and drawdown does fall under that category. You should only trade with a certain amount of risk you are comfortable with that is normally between 1-4%. 1% is being safe where 4% is very aggressive. The more you risk the more you can lose.