Author: Shams ul Zoha
Drawdown in trading refers to the amount of risk exposure your account faces. As you open up a position on any financial instrument, your trade will not hit the desired profit in one go; instead, it will face some ups and downs from the initial entry point. The executions moving against your position alert the performance statistic to note the initial equity depreciation. While it may seem absurd, some traders use this type of trading with a high risk as their primary strategy. An example is where an investor with $10,000 in his balance opens a long position on GBP/USD at 1.13000. He does not have a stop loss and would welcome any downside to getting to his profit of 50 pips, i.e., 1.13500.
Types of drawdown
There are two major types of drawdown in trading:
Absolute. This type of drawdown is the amount of downside your account suffers from its first equity level. While testing out your strategy, if you find out the value is 0, no equity or balance was negative.
Maximal. Traders are more interested in maximal drawdown if the absolute comes out to be minimal. This value can tell you the amount of exposure your balance or equity receives while being at a point higher than the initial balance. The depth of the losing streak informs you how well your strategy does after making some profit out of it.
Drawdown trading strategies
There are several strategies developed around the concept of drawdown to help in increasing the potential upside.
Hedging is one of the most common strategies amongst traders. Whenever a position moves against the desired direction, a market participant will start opening positions towards the stop loss to hedge the risk. In the case of hitting the exit point, the drawdown would be lower than the proposed initial value. At first, this form of technique was limited by brokers; however, many exchanges have special accounts catering for this type of trading nowadays.
The martingale is more like a gambling strategy where a trader increases his position size on each loss to recover the initial drawdown. For example, to make up for the negative $100 from the 1 lot trade on EUR/USD with 10 pips as SL and TP, a trader opens a new trade with the same settings, except he increases his size from 1 to 2 lots. If he wins, he makes $200 that covers the $100 drawdown.
As the name indicates, this type of trading involves opening up new trades by placing trades in a grid from the current quote. The difference between each position can differ from 1 to 100 pips, depending on the strategy.
Drawdown trading in EAs
Expert advisors typically exploit martingale, hedging, and grid trading strategies as they are much faster, efficient, and free of emotions. As a result, they experience frequent max drawdown ranging from 20 to 50%, with the monthly gains standing at 1 to 20%. To identify if a robot is using drawdown trading, consider taking a look at the balance and equity curves. The two lines will constantly be separate from one another, with the equity curve dropping significantly.
Image 1. The blue line represents the balance, while the green one is for equity. Notice how the green line drops suddenly and then comes back to meet with the blue one.
Benefits and demerits of drawdown trading
Drawdown trading comes with specific pros and cons that a trader must know before committing to this strategy. These are the advantages:
Requires less effort from the traders' side.
The market is cluttered with automated trading software that offers drawdown trading, providing you with plenty of choices.
Your winning rate will increase as your trades hit fewer stop losses.
With maximum and absolute drawdown forex values, you can identify the potential well-being of a strategy or an expert advisor.
While the disadvantages are as follows:
You expose your portfolio to a high amount of risk. The chances of receiving a margin call increase.
It requires a lot of time to recover from significant drawdowns. The great recession of 2007 to 2009, where the exposure was 50%, required recovery to 100% to get back to the initial status.
This form of trading is only suitable for professional traders who can handle significant drawdowns, while maintaining their psychology.
About Forex Copier
Forex Copier is an automated software that helps you copy your trades on the same or different PCs. It has two versions:
Forex Copier remote 2 for copying trades remotely from one MetaTrader® platform to another.
Forex Copier 3 copies trade between MetaTrader® platforms on similar PCs.
The copy trading software has many valuable features, including lot/risk management, price adjustments, order filtering, tweaking SL/TP, and emergency stops to help you get an easy edge in the industry. It is possible to diversify your trading accounts and brokers by distributing your equity over several portfolios and using the auto trade copier to copy positions from one account to all of the others. You can also choose to sell subscriptions to your signals and EAs to investors worldwide, with or without access to their login credentials.
The scope here is unlimited, as the Forex Copier can help gurus in teaching by sharing their executions. For traders on a losing streak, the mirror trading software offers a reverse mode that turns all incoming buys into sales and vice versa with modifications of the exit and entry points.