What is Drawdown in Forex?
There is an undeniable influx of people who are interested in Forex trading. Every inexperienced trader is determined to earn some easy money on the foreign exchange market, but this is only achievable with the right strategy and a reasonable amount of knowledge.
Earning money on Forex revolves around buying a specific currency when its price is low, and selling it after its value has grown. Understanding these concepts is enough to dip your toes in the water, but to achieve bigger success, you have to get familiar with more advanced terminology.
Drawdown is the difference between the current high point of money on your account and the next low point. This difference shows the capital you lost due to unfortunate trades. Losing money on trades is called a drawdown. If you decide to start trading with a $5000, but after some bad trades you end up with $4000, your account balance has suffered a $1000 drawdown. Although this experience is very unpleasant, it is a great way to get the feel of trading on Forex and learn from your mistakes.
Experiencing a drawdown allows you to evaluate the durability of your trading system. A big drawdown can put your trading system into jeopardy. Suffering a huge 50% drawdown puts you into serious danger. You'll have to be very smart about your next trades because you'll need a 100% return just to recover your account balance.
Big investors on Wall Street are very joyful with a 1/5 of profit a year. Experienced investors love to implement aggressive, high risk, high reward strategies, which often can result in a serious drawdown. When it happens, it is advised to utilize a safer, more consistent trading strategy, which will readjust your trading system. Less experienced traders get emotional and feel compelled to over-trade just to get even, which more than often results in even a bigger drawdown.
Over-trading and using too much leverage will most likely lead to a bad trade with serious consequences. Instead of making peace with their bad trade, traders get too confident and aggressive. To avoid even bigger drawdowns, cut your unreasonable trades and try to implement risk-management strategies to stabilize your situation. One good trade is definitely not the way to make a great career, but one disastrous trade will definitely cut it short.
Huge drawdowns can take a toll on your physical and mental health. Big trades have ruined the lives of many traders, so the best way to avoid such disasters is to utilize a trading plan, based on a specific algorithm and a high level of risk management, instead of relying on your emotions.
The best way to avoid big drawdowns is to implement a specific limit of any drawdown you’ll be willing to take. In the world of investors, it is called a stop-loss point. Utilizing automated trading systems with proper supervision will help you avoid trading decisions entirely based on your emotional state. Focus on your strategy, manage your risks, and know when to get out.