Drawdown refers to the amount of money lost when a series of losing trades occur. Drawdown is measured from a relative high point to a relative low point in your account and is usually expressed as a percentage compared to the starting capital.
Your account has $10,000 and you have 10 losing trades in a row of $500 each. Then your account size is $5,000 and your loss is $5,000. That would be a 50% drawdown.
The main difference between drawdown and losing is that a drawdown is only temporary, which gives you the chance to get your money back. It is important to know how much drawdown your strategy might produce or how much drawdown you can handle psychologically.
Drawdown limit in the tradimo $50,000 Trading Challenge
Trading competitions where results are based on return only have more to do with gambling than real trading skills. In order to create a fair competition and find the most astute traders tradimo introduced a 20% drawdown limit in the rules of their $50,000 Trading Challenge.
How is drawdown measured in the competition?
During the competition an algorithm created bycollects the value of all participating accounts every 5 seconds. The algorithm takes note of the latest highest equity high and calculates the percentage difference in case the equity drops. If this value reaches 20% percent, the participant will be removed from the current stage of the competition.
If you have been disqualified from the demo stage don't worry, you will still be eligible to participate in the real money competition coming in November this year with even bigger prizes such as the right to manage a $50,000 Trading account. Watch out for our announcements for more details.
Your starting balance is $15,000, you open a trade which goes right in your favor and your floating P&L is +$1,000, your equity $16,000. Then news come out and the trade turns against you and suddenly you are -$500 down. How much is your drawdown?
Your drawdown will be calculated from your $16,000 equity peak to your $14,500 equity low and come to 9.37%. However you decide the trade is not finished yet and you keep it open. A little later the markets prove you were right and you end up closing the trade for a profit of $200. Even though you made money on the trade you did suffer a drawdown of 9.37% which was reported to the broker by the algo.
How does MT4 calculate drawdown?
It is recommended that you keep an eye on your drawdown while in the competition as well when you trade your own account. However if you use the MT4 Detailed Reports you will notice that the statement displays different figures and actually it is possible that you get disqualified even when your drawdown is less than 20% as indicated in your Metatrader 4.
How is it possible to get disqualified when MT4 drawdown shows less than 20%?
The answer lies in the calculation method. MT4 only takes closed trades into account (balance) and does not record change in equity. If we use the example above while your equity went from a high of $16,000 down to $14,500 low MT4 would have recorded 0% drawdown only because you chose to not close the trade.
This method is not just inaccurate but also dangerous, because it encourages traders to keep their losing trades open pretending their balance is intact while their equity is melting down. One of the first and most important lessons you have to learn as a trader is to accept you are wrong and take losing trades. Calculating drawdown based on equity and eliminating participants according to excessive negative equity swings like we do it in our $50,000 Trading Challenge is the best way to tell talented traders and gamblers apart.
Investors focus on drawdown, not returns
who have large amounts of money at their disposal are certainly interested in growing their capital but their primary goal is to preserve it. Hence they look for that offer decent returns with very low drawdown. A fund that doubles its value one week only to give it all back the next, is not attractive for serious investors. They look for fund managers who can produce steady, consistent results with very little downside. And it is exactly this kind of trader we are looking for in our tradimo $50,000 Trading Challenge.
To learn more about risk management and how psychology plays an important role in trading, visit: