Both have a profit factor of 1.25 over a 10-year period, but exhibit very different profiles. Two equity curves will henceforth be used to compare the different drawdowns. You can open the report in Excel and carry out the computations. The following drawdown measures can be easily computed using the closed trade profits/losses from MT4’s default strategy tester report. If you develop with variable position sizing, or wish to measure drawdowns as a fraction of equity, percentage drawdowns will be more appropriate. Percentage drawdowns would be unsuitable because the effect of each trade on the account equity would vary as the account grows/shrinks. % Drawdownĭuring strategy development, where I backtest with a fixed lot size, I measure drawdowns in absolute dollar terms. For the remainder of this post, we will focus on closed trade drawdown. As shown below, I currently use Myfxbook to track my live trading performance, where both the open-trade and closed-trade equity curves (yellow and red, respectively) are updated daily.ĭespite these advantages, closed trade drawdown is easier to compute and is commonly featured in trading software. The higher the measurement frequency, the more accurately you can track your drawdown variations over the course of your trades. If you use an open-trade equity curve, it pays to find out how frequently the open-trade drawdown is measured. If you trade a small account and barely meet your margin requirements, open-trade drawdown may be needed for risk assessment. Here the closed-trade curve neglects to show if the winning trade was ever in a losing position. For longer-term trend following strategies, this profit retracement can make a big difference to your bottom line.įor Curve 2 (blue), the trade immediately goes negative, reaching a $200 open trade drawdown before recovering to close in profits. In this case, the closed-trade equity curve fails to capture the open trade profit retracement. But if you take floating profits/losses into account as well, you will likely get an open-trade equity curve resembling the blue or orange lines above.įor Curve 1 (orange), a $300 open profit was accrued, of which $200 was lost by the time the trade was closed. If you use a closed-trade equity curve, you will get the green line, which shows zero drawdown. Suppose you just closed your first trade with a profit of $100. Consider the hypothetical scenarios below on how an open trade may play out. If you instead have an equity curve built by taking the sum of closed trade equity and open profits/losses, you can track your open-trade drawdown. Account equity was not tracked when the trades were open. The chart above displays closed-trade drawdown it was constructed using only the profit/loss of each closed trade. At the right end of the equity curve, the absence of new equity peaks creates a long series of drawdown values. Whenever a new equity peak is reached (green dot), the current drawdown is 0. The chart below shows an equity curve and its corresponding drawdown distribution as a function of trades. For example, if your peak equity is $5000, and your current equity is $4000, you have a $1000 drawdown.Īs trading progresses, your current drawdown will fluctuate in response to your individual trade outcomes. Drawdown is the decline in account equity from a prior equity peak. Most traders quantify risk by measuring the drawdowns incurred by their strategies or portfolios. Risk management is a cornerstone of successful trading.
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