Drawdown in financial investment is no longer a strange term to many people. This is a phrase used to describe the decline in capital in investment. At the same time, this is also a tool to help investors evaluate and control strategies. Let’s join Forex Trading to learn in more detail what the concept of drawdown is.
What is drawdown? Learn in detail about the drawdown feature
To ensure safe capital for investors. Traders need to reduce negative account volatility. Understanding what drawdown is will help investors better control their capital.
What are drawdown basics?
Drawdown is the decline of an investment. A trading account or fund goes from high to low over some time. The draw is usually expressed as a percentage between the next high and the next low.
If the trading account has 10,000 USD and the amount drops to 9,000 USD before returning to over 10,000 USD. This trading account is considered to have decreased by 10%. It is important to measure the historical risk of different risky investments. To be able to compare fund performance or track the development of each business.
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Formula to calculate drawdown in forex
The ratio of the drawdown is calculated by the formula capital bottom minus capital peak and then divided by capital peak. In investing, using the peak of capital minus the bottom of capital will give a positive result. However, to accurately represent the nature of the decrease in capital, we will use the bottom of the capital minus the peak of the capital.
Detailed analysis of drawdown types available in Forex
Currently, there are 3 main types of forex that investors need to understand. Let’s analyze each form in detail now.
Analyzing absolute drawdown in forex
This is the largest reduction compared to the investor’s initial capital. The absolute discount is expressed in a certain currency (USD, EUR,…). Shows how much money the investor has gained or lost compared to the capital.
If the price line of the chart continues to move in the wrong direction. This means that this number is larger and your loss will be higher. If this indicator is 0, you are not currently losing money or have not started trading yet.
What is maximum drawdown analysis?
Maximum drawdown is also abbreviated as MDD. This term is used to express the maximum capital loss. And they are calculated from the highest peak to the lowest bottom. The value of the maximum drawdown is displayed in absolute currency.
Compared to absolute drawdown, MDD will represent a higher level of risk. Because this is the deepest decline during the period of holding the order. To be able to calculate MDD and limit it to the lowest level, investors can set TP and SL.
Analyzing relative drawdown in forex
Relative drawdown is essentially MDD compared to the initial capital but expressed in percentage. The formula for relative drawdown is MDD/highest capital peak. When looking at relatives, it is easy to visualize the risk level of the account through the percentage. When talking about drawdown, relative and absolute are mentioned more often than maximum.
Apply pivot point strategy in case of drawdown
What is a pivot point? Pivot points are a chart format and are commonly used to identify support and resistance levels. Based on pivot points, investors can easily identify price fluctuation areas and increase trading possibilities.
Use a combination of pivot points and reversal candlestick patterns
To avoid encountering a drawdown, investors need to have reasonable trading strategies and trading methods. Using pivot chart points along with candlestick reversal patterns is also a method to limit drawdown.
With this method, the price tends to reverse at the resistance and support zones created by the PP line. A reversal is more likely to occur if confirmed by a candlestick reversal pattern. Currently, investors make trades similar to the strategy when the price hits the support-resistance level.
If the price is in the support and resistance zone, the entry point is the closing price of the candle. Regarding the sell order, the stop loss position is above the resistance line. For buy orders, place the stop loss below the support line. Take profit at resistance levels R1, R2, and R3 with buy orders, and take profits at support levels S1, S2, and S3 with sell orders.
Combine using breakout points with pivot charts in drawdown
Using breakout points in combination with pivot charts is also a way to limit drawdown. If the price breaks the major support or resistance zone and increases or decreases sharply, investors can place an order as follows. Place a buy order when the price breaks through the resistance levels R1, R2, and R3, and increases.
Or place a sell order when the price breaks through the support levels S1, S2, and S3 and falls. The moment the candle breaks out or returns to test the broken resistance level after the price breaks out. By placing this order, you close the gap, but you may lose the opportunity if the price does not reverse and go straight. Above the line below the broken resistance line of buy and sell orders.
Using the RSI trading indicator in technical analysis
RSI divergence strategy is no longer a strange indicator for traders. RSI is used to measure fluctuations between two extremes: the buying and selling poles. If either side is overextended, the RSI indicator will help you recognize this and limit the drawdown.
The default setting for the RSI indicator is 14. This means that the RSI measures the average increase or decrease of the last 14 candles. In addition, it also provides a deeper analysis of the size of the candle.
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When the RSI exceeds 70, it means the market is overbought, and vice versa. If the RSI exceeds 30, it means the market is oversold. When the RSI is rising, it simply means there are more bullish candles than the relative strength index is continuously increasing.
This shows that the market has been rising steadily for some time. And if it crosses 70, this shows that the market is in overbought mode, with a potential reversal. If we understand the role of the RSI indicator, we can see that the signals are in an overbought or oversold state.
However, whatever the indicators are, these are just supporting tools. And it cannot be 100% certain to help you avoid drawdown when trading. Investors need to prepare careful trading strategies.
Conclude
Above is the information investors need to know about the drawdown. A thorough understanding of this term will help investors proactively control their capital. The drawdown situation in trading is difficult to avoid, investors should not be too serious about this issue. Don’t forget to follow Forex Trading to update the most frequent news about the foreign exchange market.
FAQs
What is the best drawdown rate?
Currently, the lower the drawdown level, the better the investor’s investment efficiency will be.
What level of drawdown rate is acceptable?
The drawdown level of each investor should not exceed 20%. The higher the ratio means the more difficult it is to recover capital.
What does Drawdown mean in foreign exchange investment?
They help investors manage losses in each portfolio. Besides, it also helps investors warn about account losses.
