WHAT IS DRAWDOWN | 3 Types Of Drawdown Explained 📚
In my videos, I frequently use the term "drawdown".
Many of you asked me to explain the meaning of that term and share some examples.
The account drawdown is the highest observed loss from the highest
value of the deposit to the lowest value of the deposit at
a certain period of time.
Imagine you started to trade with 10,000$ account.
At the end of the year, your account size reached 15,000$.
However, at some point through the year the deposit value dropped to 6,000$. It was the absolute minimum for the one-year period.
At some point, your net loss was -4,000$ or 40% of your account balance.
The account drawdown is 40%.
❗️Knowing the account drawdown is very important for the risk assessment of the trading strategy. Usually, 50% and bigger drawdown signifies an extremely high risk.
There are 3 types of drawdown to know.
Current drawdown - a temporary drawdown associated
with the negative total value of opened trading position(s)
Once you start trading with 10,000$ deposit, you open several trading positions. Being opened, with the constant price movements, your potential gains fluctuates from positive to negative.
For examples, with 3 active trades: EURUSD (-500$ at present); GBPUSD (+200$ at present); GOLD (-100$ at present) your current account drawdown is -400$ or 4% of your deposit.
Fixed drawdown - the negative value of the closed trading
position(s) at present for a certain period of time.
While some of your trades remain active, some are already closed.
Imagine the same deposit - 10,000$.
On Monday you opened 6 trades, 2 still remain active and 4 are already closed. Your total loss from your closed trades is -500$. Your fixed Monday's drawdown is 5%.
Maximum Drawdown - the maximum observed loss from
the highest value of the deposit before a new maximum
Starting to trade with 10,000$ you are already trading for 5 years.
Your account were growing rapidly and at some moment it reached 25,000$. Then the recession started. You faced a dramatic loss of 12,500$ before you started to recover.
That was the maximum observed loss for the period.
Your maximum account drawdown was 50%.
❗️Different types of drawdown give a lot of insights about a trading strategy. Its proper assessment will help to spot a high risk strategy and to find a conservative one.
Constantly monitor your account drawdown and always check the numbers.
What is your highest account drawdown?