The Meaning of Drawdown in Forex

In this educational article we will take a look at the drawdown which is the difference between profits and losses in your forex account.

What is Drawdown in forex ?

Key Takeaways:

  • Drawdown in forex is the difference between your account’s high and low points. This will give a good indication of how much money is lost through Forex trading. This difference is displayed as a percentage.
  • Drawdown is an excellent indicator for Forex traders wanting to grasp their losses. However, when traders experience a drawdown, they should adjust their strategy to recoup losses.
  • For example: Let’s say your starting balance is $1,000. After a poor trade, the balance lowers to $800. The drawdown will be 20%, even if the balance rises again.

Why Do Forex Traders Monitor Drawdowns?

Risk management is one of the most critical factors in Forex trading. Traders need to understand the market volatility and know how to minimize their losses. This is why drawdown is such an important tool, as a significant drawdown will place the trader in an unsustainable position.

When Forex trading, traders want to keep the drawdown as low as possible. The drawdown will give them a great indication of their system over the long run. A comprehensive understanding of drawdowns is crucial to your trading setup’s viability.

How to Control Drawdowns

The learning curve in Forex trading never ends. To limit the damage to a trader’s account, they should take the following into account:

Every Trade Won’t Be a Winner

Because every trade cannot be a winner, traders need to know when to cut their losses in a bad trade. However, traders shouldn’t let every trade defy their whole strategy and try and take the emotion out of trading.

Add Stop Losses

Depending on the percentage of drawdown a trader can tolerate, a stop loss order should be set up accordingly, so they can protect their capital. For example, let’s say the trader’s balance is $1,000, and they are comfortable with a 20% drawdown. The signal provider will close all the positions once their capital drop to $800.

Minimize the Risk

Traders should keep their trades to a minimum to eliminate unnecessary risk and significant losses. If the trade goes wrong, the trader will only lose that small percentage of his capital. Another bonus of starting small is traders can practice, feel their emotions, and evaluate their plan before increasing their trades.

Forex is not pyramid scheme and definitely not a get rich quick scheme. When it comes to trading, there will always be profits and losses. Managing the losses is what separates successful traders from losers.

Focus on a Long-Term Strategy

A trader needs to know why they are trading and stick to their strategy over the long term. This will help keep their trades on track and improve their chance of success.

Implement a Drawdown Cap

Over and above a stop loss, the drawdown cap allows the trader to set how much they are willing to lose over a week or month period. If the trader is only happy with a 3% drawdown, they will stop trading as soon as it reaches this limit.

Final Thoughts

It’s always in the trader’s best interest to do proper research and due diligence before trading. There are many factors to consider on the path to success in Forex trading.

We hope the above guidelines will assist in keeping drawdowns to a minimum when they eventually happen. Unfortunately, traders don’t want to burn through their accounts too fast, as making a solid return takes time and patience.