Forex Drawdown
Forex investors should know how to evaluate investment strategies based on the risks that their accounts are exposed to based on forex drawdown. Forex drawdown is the amount, either in absolute value or percentage terms, of decline in a forex account’s equity through the course of trading.
For any given instance that a position is opened in trading account, the value of its equity changes from time to time depending on the current floating profit or floating loss that the open trade is incurring. Even if the said trade has not yet been closed and liquidated, the equity also rises and falls as the price for the traded currency pair fluctuates.
Forex drawdown is important in determining if a forex strategy is a good strategy. Forex drawdown gives the forex investor an idea of how risky a forex strategy is. If a trading strategy has a relatively large amount of drawdown when compared as a percentage to the account’s equity, that strategy may be considered risky. It is risky because it puts excessive strain of the account’s equity for the open trades it takes before it can make a profit. And an excessive forex drawdown may also eventually lead to a forex account losing a considerable part of its value as a result of risky trading strategies.
Forex drawdown can also be used to evaluate forex trading signal providers. In the same way that strategies are assessed by the risk factor that it exposes a trading account, forex signal providers should also be evaluated with the amount of risk their signals put on an account. Forex trading signal provider should be able to give profitable trading signals to their clients without taking too much risks. The value of any amount of profit generated by trading signals should be analyzed in view of the risks that were taken during the trade to achieve that level of profitability. As an example, if a forex signal provider suffered a floating loss of 100 pips before the price of the currency pair turned around and hit a 10 pip profit, is it worth it for the investor? The forex investor risked 100 pips to be able to gain just 10 pips of profit.
While the example above was made using pips as the basis of analysis, the more correct and more accurate way of evaluating forex drawdown and the risks involved should be by using the percentages based on the forex account’s equity. Of course, different forex investors have different appetites for risk. And depending on how much risk you are willing to take, the amount of forex drawdown varies from one investor to the next. But remember that most of the time, the amount of risk that a forex investor is willing to take, based on the relative amount of forex drawdown that he exposes his account to with his trades, usually determines if his account can survive the volatile markets of forex in the long run. The profitability of a forex account is usually correlated to the length of time the account stays alive to trade in the forex markets.
So evaluate the risk factor you are willing to take with your forex account by computing the forex drawdown you are willing to take with every trade that you open. Proper capital management should dictate that forex drawdown be maintained at a minimal amount for an account to remain profitable in the long run.