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 stocks money management strategies explained on this learn Stocks Trading tutorial website.
When it comes to trading, the trading risks to be managed are potential losses. Using stocks money management guidelines won't only protect your stock account but also make you profitable in the long run.
Draw-down
As traders the number one trading risk is known as draw-down - this is the sum of money you have lost in your stock trading account on one stocks transaction.
If you have $10,000 capital & you make a loss in a single trade of $500, then your drawdown is $500 divided by $10,000 which is 5% draw-down.
Maximum Draw-down
This is the total sum of money you've lost in your stock trading account before you start making profitable trades. For example if you have $10,000 capital & make five consecutive losing trade positions with a total of $1,500 trading loss before making 10 winning trades with a total of $4,000 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 MT4 Guide
Stocks Money Management
The examples illustrated & described below shows the contrast between risking a small percent of your trading capital compared to risking a higher percentage. Good investment principles requires you as a not to risk more than 2% of your total account equity.
Percentage Risk Technique
2% & 10% Risk Rule
There's a large contrast between risking 2 percent of your equity compared to risking 10% of your equity on a single transaction.
If you happened to go through a losing streak and lost only 20 trades in a row, you'd have gone from starting trading account balance of $50,000 to having only $6,750 left in your account if you risked 10 % on each trade position. You would have lost over 87.50% of your equity.
However, if you risked only 2 % you would have still had $34,055 which is only a 32 % loss of your total account equity. This is why it's best to use the 2% risk management strategy
The difference between risking 2 % & 10 % is that if you risked 2 % you'd still have $34,055after 20 losing trades.
However, if you risked 10 % you would only have $32,805 after only 5 losing trades that is less than what you would have if you risked only 2 % of your trading account and lost all 20 trades.
The point is you want to setup your rules so that when you do have a loss making period, you'll still have enough trading capital to trade the next time.
If you lost 87.50% of your trading capital you'd have to make 640% profit to get back to break-even.
As compared to if you lost 32 % of your capital you would have to make 47% profit to go back to break-even. To compare it with the examples 47 % is much easier to break even than 640 % is.
Chart below shows what percent you'd have to make to get back to break even if you were to lose a certain percentage of your capital.
Concept of Break Even
Account Equity & Break Even
At 50% draw-down, a trader would have to earn 100 % on their invested capital - a feat accomplished by less than 5% of all traders globally - just to break even on an-accounta-trading-account with a 50% loss.
At 80% draw-down, one must quadruple their equity just to bring it back to its initial equity. This is what is called to "break-even" 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. Do not accept to lose more than 2 percent of your account equity on any 1 single trade transaction.
Stocks risk management is about only risking a small percentage of your trading capital in each trade transaction so that you can survive your losing streaks and avoid a large draw down on your account.
In Stocks, traders use ++stop-ordersstop-loss-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 stocks money management system and a plan. To be in Stocks Trading or in any other business you must make decisions involving some risk. All aspects should be measured to keep risk to a minimum & use the above tips on this guide.
Ask yourself? Some Tips
1. Can the risks to your investing activities be identified, what forms do they take? & are they clearly understood & planned for? All the risks should be taken care of in your Stocks Trading plan.
2. Do you grade the risks faced by you when trading in a structured way? - Do you've 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 data & based on a strategy or not? Have you read about stock systems here on this website tutorial 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 trading activities exist? - Do you hold trades longterm or shortterm? 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 Stocks Trading risks can be reduced or hedged and what it would cost if you did not include these measures to reduce potential loss, & what impact would it make to any upside of your profit?
9. Have your rules been adequately addressed, to ensure that you make and keep your profits.