When it comes to forex trading, drawdown is the difference between balance and equity from peak to trough. Keeping the drawdown as low as possible is part of risk management. A higher drawdown means higher risk and a higher probability of wiping the account, whereas a lower drawdown means lower risk and a lower risk of incurring losses.
Drawdown shows the maximum risk occurring on the trading account and indicates how risky trades or the strategy can be. The majority of professional traders recommend to keep the drawdown between 5% to 15% in any situation.
Let me explain drawdown in an example. Lets say you have $1000 in your account and your floating loss is $100. This means that your account drawdown is 10% and if you close this position in $100 loss then your realised drawdown is $10. Now, lets say if you have three open positions each with $100 loss; your account total drawdown is 30%.
Causes of a Drawdown
Take into consideration the list below that all cause a drawdown:
- Poor risk management
- Multiple open positions
- Trades without stop loss
- Trades with wider stop loss
- High Leverage
How to Avoid a Large Drawdown
Remember that drawdown is a part of trading. You can however take the following steps to minimise it.
- Build a proper trading plan
- Use low volume
- Use a proper predefined stop loss
- Set a maximum cap for drawdown
- Avoid opening too many positions
- Don’t use high leverage
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