What is a drawdown?

In very simple terms Drawdown is the percentage of capital you have lost.

Consider opening an account with $10,000 and then losing $5000. The percentage lost is 50% and is your Drawdown.

In practice when your capital reduces as a result of a losing streak, drawdown can be defined as the amount by which your account has fallen in value relative to the highest value that was previously attained. Subtracting the value at any given point from the highest value that occurred prior to the current value gives you drawdown. Unless you have a way of looking into the future, there will be times when you lose a few trades in quick succession. The more that you risk on each trade and the more consecutive losing trades that you experience, the larger your drawdown will be.



Now you know that in the long-run you can make money with a well thought out forex trading plan. It is quite similar to starting a business. A good business reaches its true potential only if it can survive the bad times to make the most when the market turns favourable. The table below summarizes the extra effort required to make up lost capital at different levels of drawdown (or loss of capital). As you can see, at 50% drawdown you need to make a 100% return to just reach your original level.



So, a primary consideration for any new strategy you develop is to try and minimize the degree of drawdown that you might expect. We will discus this in some more detail with importance of understanding Risk Reward.

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