Drawdown in trading

Drawdown in trading

What is drawdown in trading?

A drawdown in trading is a drop from a peak to a minimum over a specified period. It’s usually given as a percentage, but dollar terms can also be used if applicable to the particular trader. If there is $10,000 in the trading account and the funds fall to $9,000 before climbing back above $10,000, then the trading account is experiencing a 10% drawdown.

A drawdown refers to how much an investment or trading account has fallen from a peak before it recovers to a peak. Drawdowns are a measure of downward volatility.

Knowing the drawdown value is critical to managing market turbulence, measuring volatility and inherent risk associated with your investment. When the value of an investment falls below the highest and then re-crosses the highest peak seen during the investment period, a drawdown is recorded. The longer the value of an asset stays below the last peak, the more likely it is to have a lower bottom, which increases the potential drawdown.

When evaluating drawdowns, traders should also take into account the time required for the drawdown to recover.

Drawdown and loss are not necessarily the same thing. Most traders view drawdowns as a peak-to-trough indicator, while losses usually refer to the purchase price relative to the current or exit price.

What is the difference between a trading drawdown and a banking drawdown?

Drawdown applies to both investment/trading and banking. In trading or investing, drawdown refers to a decrease in equity. Basically, it‘s the difference between the peak value of the capital that your account has reached and the lowest level of capital reached during a certain period. In the banking world, a drawdown means gradual access to part or eventually all of a credit line. This means that in investing, a drawdown determines your level of risk, while in banking, a drawdown determines your level of liability.

Why are drawdowns important in investment?

Risk management is a key factor in investing or trading. When developing a strategy, traders look for one that gives them an advantage in the market. A strategy that has 80% success doesn’t mean that 8 trades out of 10 will be profitable. Inevitably there will be periods when there will be a losing streak. This is where drawdowns come in. Drawdowns are an important part of any trading activity and any risk management plan should detail how to deal with them effectively so as not to jeopardize the portfolio.

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2022-06-10 • Updated

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