Draw Down and Maximum Draw-down

In business in order to make a profit one must learn how to manage risks. To make profits in trading you need to learn about various indices trading money management methods discussed on this learn Indices lesson web site.

When it comes to trading, the risks to be managed are potential losses. Using indices trading money management rules will not only protect your trading account but also make you profitable in the long run.

Draw-down

As traders the number one risk is known as draw-down - this is the amount of money you have lost in your account on a single trade transaction.

If you have $10,000 capital and you make a loss in one trade of $500, then your drawdown is $500 divided by $10,000 which is 5 percent draw-down.

Maximum Draw-down

This is the total amount of money you have lost in your account before you start making profitable trades. For example if you have $10,000 capital and make 5 consecutive losing trade transactions with a total of $1,500 loss before making 10 winning trades with a total of $4,000 trading profit. Then the draw down is $1,500 divided by $10,000, which is 15% maximum draw-down.

DrawDown is $442.82 (4.40%)

Maximum Draw Down is $1,499.39 (13.56 %)

To learn how to generate the above reports using MT4 platform: Generate Reports on MetaTrader 4 Tutorial

Indices Trading Money Management

The example explained below shows the difference between risking a small percentage of your capital compared to risking a higher %. Good investment principles requires you as a not to risk more than 2 percent of your total trading account equity.

Percent Risk Technique

2 percent and 10 percent Risk Rule

There's a big contrast between risking 2% of your equity compared to risking 10% of your equity on one transaction.

If you happened to experience a losing streak & lost only 20 trades in a row, you would have gone from beggining trading account balance of $50,000 to having only $6,750 left in your trading account if you risked 10% on each trade transaction. You would have lost over 87.5 % of your equity.

However, if you only risked 2% you would have still had $34,055 which is only a 32 % loss of your total equity. This is why it's best to use the 2 percent risk management method

The difference between risking 2% and 10% is that if you risked 2 % you would still have $34,055 after 20 losing trades.

However, if you risked 10% you'd only have $32,805 after only 5 losing trades that's less than what you would have if you risked only 2% of your trading account and lost all 20 trades.

The point is that you want to setup your rules so that when you do have a loss making period, you'll still have enough capital to trade next time.

If you lost 87.5 % of your trading capital you'd have to make 640% profit to get back to break even.

As compared to if you lost 32 percent of your capital you'd have to make 47 % profit to get back to break-even. To compare it with the examples 47% is much easier to breakeven than 640% is.

Chart below shows what percent you would have to make to get back to break even if you were to lose a certain % of your capital.

Concept of Break-Even

Account Equity and Break-Even

At 50% draw-down, one would have to earn 100% on their invested capital - a task accomplished by less than 5 percent of all traders globally - just to break even on an-accounta-trading-account with a 50% loss.

At 80% draw-down, a trader must quadruple their equity just to bring it back to its initial equity. This is what is called to "breakeven" i.e. Get back to your original trading account balance that you deposited.

The more you lose, the harder it is to make it back to your original account size.

This is the reason why you should do everything you can to PROTECT your equity. Don't accept to lose more than 2% of your equity on any 1 single trade position.

Indices trading money management is about only risking a small percent of your trading capital in each trade transaction so that you can survive your losing streaks & avoid a large draw down on your account.

In Indices, traders use stop loss stock orders which are put in order to minimize losses. Controlling risks it involves putting a stop order after placing an order.

Effective Risk Management

Effective risk management requires controlling all the trading risks. A trader should create a clear indices trading money management system and a plan. To be in Indices or in any other business you must make decisions involving some risk. All aspects should be measured to keep risk to a minimum and use the above tips on this tutorial.

Ask yourself? Some Tips

1. Can the risks to your investing activities be identified, what forms do they take? and are they clearly understood and planned for? All the risks should be taken care of in your Indices plan.

2. Do you grade the risks faced by you when trading in a structured way? - Do you have a trading plan? - have you read about this course which is extensively covered discussed here on this Site.

3. Do you know the maximum potential risk of each exposure for each transaction that you place?

4. Are decisions made on the basis of reliable and timely information and based on a strategy or not? Have you read about trading systems here on this web site guide tutorials.

5. Are the risks big in relation to the turnover of your invested capital and what impact could they have on your profits margins & your margin requirements?

6. Over what trading time periods do the risks of your trade activities exist? - Do you hold trades long-term or short-term? what type of trader are you?

7. Are the exposures a one-off or are they recurring?

8. Do you know enough about the ways in which your Indices risks can be reduced or hedged and what it would cost if you did not include these measures to reduce potential loss, and what impact would it make to any upside of your profit?

9. Have your rules been adequately addressed, to ensure that you make & keep your profits.