Living Through a Draw-Down is a Critical Skill for Traders

17 min read

Dear traders,

What is one of the most important skills a trader must master? Although traders need to be versatile in multiple skills, the ability to handle draw-downs probably makes it in the top three.

Trading without handling draw-downs is almost like swimming on land. It’s difficult to trade with accepting risk. And if taking risk with your trading capital makes you too nervous, then trading might not be the right business for that trader.

This article explains how trading goes hand in hand with winning and losing streaks. We also share some anecdotes that might help traders with the psychological aspect of draw-downs.

The Sensitivity of Draw-Downs

Draw-down is a sensitive topic for all traders and investors. This is understandable because drawdowns heavily impact a trader’s psychology. Most traders underestimate their tolerance for draw-downs. They think handling 20, 30 or 50% draw-down or seeing the account go sideways for 3 months is doable beforehand… Until it actually happens… And then they become nervous. It’s an understandable process. But it shows why traders need to be prepared before these streaks happen.

These difficulties with trading psychology occur with both manual and automated trading. We must be able to deal with trading streaks and taking risks while not losing our nerves…. Because otherwise traders will into the trap of making classical errors such as: 

  • Trying to compensate short-term streaks by altering our systems, entries, and exits.  
  • Increasing the risk to win back the losses.
  • Decreasing the risk because of fear and lack of confidence. 
  • Chasing setups that do not belong to the system.
  • Avoiding setups that do belong to the system.
  • Etc etc.

Losing and winning streaks are an unavoidable part of the trading business. All systems go through draw-downs. Why? Because trading with leverage entails high risk. Putting 1-5% per trade at risk each trade is not a small sum. That is why you see risk warnings everywhere stating that only risk capital should be used. Simply said, without risk and draw-downs, the potential for such high profits would not exist. the gains that ecsLIVE, ecsCAMMACD, and Ultima EA have realized are incomparable to any other gains seen in the traditional stock market, real estate market, or traditional investing. 

But traders need to realize that large potential gains go along with large potential draw-downs and sometimes, even full account loss. Simply said, you cannot earn big without draw-downs or seeing the account go sideways. If traders cannot handle draw-downs, then it’s best if they trade with very small risk or choose to trade less risky methods like options trading. If a trader wants full safety, then it could be better to put the capital on a savings account and collect 1% a year. There is no expected draw-down in this case.

Nenad Explains How to Calculate Draw-downs

It is very important to make a difference between drawdown from profits and drawdown from the deposit. This is something that unfortunately many traders don’t have a clue of.

Let’s make it clear. There are 3 different types of draw-down.

  • Absolute draw-down
  • Maximal draw-down
  • Relative draw-down

Absolute DrawDown

The difference between the initial deposit and the smallest value of the equity. It represents how much below the initial deposit level the Participant’s equity has ever fallen.

The formula is:

AbsoluteDrawDown = InitialDeposit – MinimalBalance

Maximal DrawDown

Maximal drawdown is the maximal difference between one of the local maximums and the subsequent minimum of the equity.

The formula is:

MaximalDrawDown = Max of (Maximal Peak – next Minimal Peak) 

Relative DrawDown

Relative drawdown is a ratio between the maximal drawdown and the value of the corresponding local maximum of the equity. This coefficient shows losses, in percent of equity, experienced by an Expert Advisor. Relative Drawdown in MT4’s report is calculated as a percentage of the difference of the historical equity high and equity low, against the equity high

See this account for example:

You can see that I managed to get the account from 10k to 100k. There was a withdrawal of 90k of profits. The drawdown shows 83.09%. A trader who doesn’t understand what the drawdown is might say it is too much.

But in fact it isn’t. Because 83.09 % has been made from profits, not from the deposit. Even if it was a complete 100% of DD, it would still mean the profits are 80.000EUR which is huge. 

So it is important to understand the real meaning of drawdown. Is it from deposit or from profits. I always like to risk my profits instead of the deposit. You can follow MyfxBook here. I trade my CAMMACD method which you can purchase here.

Chris’ Trading Experience with Ultima EA

When you trade the Ultima EA with 5% risk per setup, then keep in mind that the drawdowns can indeed be 25-55% of the account. Also, the EA can go sideways for a few months before we hit a win streak. Let me tell you what happened to me. 

I started in August 2019 with 4,000 euro. A few weeks later I hit a winning streak and won +85% in August 2019 and +21% in September. I kept the profits on the account and added more capital: about 13,500 euro. But after I added capital, the EA went into a drawdown. 

October 2019 saw a loss of -12% and November was -23%. My account went from an equity peak of +162% of profits down to +25%. This is the risk of adding capital later on. But I accepted it and waited patiently. December saw a decent gain of 14% but it was not enough to cover the losses from October and November. 

After 3 months, many traders lost their patience and stopped… Unfortunately for them though, they missed the next winning streak. 

In January we had a nice positive month with +16%. But in February we made a whopping +217%. The winning streak totally engulfed the draw-down. 

A lot of traders quit during Oct-Dec and missed the big win in Feb. I stayed patient and saw the account grow to a total of +818%.

March ended up at break-even, April gave us +8% and May is currently at break-even (as of 14 May). So my account has gone more or less sideways (+8%) in the last 2.5 months. Not bad after gaining +233% in January and February.

Despite that, my account is currently ahead by +600% so it is in a draw-down compared to the 818% peak. This is because we lost the gains from earlier in May (which is why we are at break-even in May 2020). 

Considering the fact that the EUR/USD has been in a range for 2 months, the results of the Ultima EA as a trending system have actually been surprisingly good. Keep in mind that trend systems usually fail in range and range systems during trends. The Ultima EA manages to survive massive range periods. Only now are we seeing a draw-down take place.

3 Solutions to Handling Drawdowns

Some traders who started later in May 2020 have missed the winning setups from earlier this month. They are probably in a draw-down of 25%. This is part of trading and the reason why it is important to keep two things in mind:

    1. Evaluate performance after long periods of time
      Judging a system performance after a few trades or weeks is too premature to make any conclusion. It is vital to review the long-term statistics to make an accurate assessment. If a trader looks at small periods of time to evaluate the performance, they will most likely be unable to focus on the long-term edge. What is long-term? For Ultima EA, at the very minimum after 6 months. We prefer a year. For manual trading, you want to at least evaluate monthly and quarterly performance.
    2. Trade with risk capital that you can afford to lose Traders should always risk capital that they can afford to lose. Otherwise they will become too nervous with each trade and each winning or losing streak. The Ultima EA trades with 5% risk which is high. A small losing streak can create a draw-down. But the Ultima EA can trade with high risk because the expected losing streak is small and that allows us to aim at high profit targets. Traders need to choose a level of risk capital that they can afford to lose, which in turn allows them to stay calm during the ups and downs and allows them to see the long-term picture. The best is not to get attached to any trade or any winning or losing streak.
    3. Risk and trade with profits
      As soon as you can, try to trade with the profits made rather than risking your own savings and capital. Of course, traders who just start cannot do that. But as soon as you have made some decent profits, you can use this tactic like Nenad, Mislav, and Chris do.

Will traders that are now in a draw-down or who are seeing their accounts go sideways for 2.5 months eventually hit a winning streak? We can never know if the same scenario will repeat. We do not own a crystal ball. However, although there are never guarantees with live trading, back-testing and live trading show that the odds are in our favour. The win percentage averages 65%. The profitability is also visible (see links down below) in the long-run. BUT this goes with ups and downs in the short-term.

Comparing Current Slow Down with the Past

There were periods in our live trading and back-testing that showed draw-downs or sideways movement for a while too. 

Live trading results ecs.CAMMACD:

Keep in mind that $90,000 was withdrawn after the account hit a total equity of $100,000. The draw-down of 83% happened after the 90k was removed and hence the draw-down occurred with about 10% of the profits.

Live trading results ecsLIVE:

Live trading Ultima EA 2020:

Live trading 2019 Ultima EA:

Here below is an overview of back-testing Ultima EA from mid 2017 to end of 2019.

2019:

2018:

2017:

Back-testing results Ultima EA links

0.5% risk per setup

1% risk per setup

3% risk per setup

5% risk per setup

Live trading results:

Nenad’s ecsCAMMACD from December 2018 

Chris’ EUR/USD 15min 5% risk from August 2019

FXDD EUR/USD 15min 3% risk from June 2019

Chris’ GBP/USD 60min 5% risk from August 2019

Mislav’s EUR/USD 15min 5% risk from August 2019

Live Q&A with Members Facing Draw-down

Here is a live Q&A with a member so you can understand our ideas better in practice.

Question from member:

“Hi, I joined in march for a 6 month rental scheme. I am trading all kinds of instruments with high risk. So far I am losing $1300 out of 3000 dollars. It  makes me worry about what is about to happen in the coming month. I am not blaming but please do something to stop this losing streak. I was so confident till last week that I would get some money to extend the EA for one more year. I am so genuinely concerned about protecting the capital. As the capital was a loan I took out a credit card and now no job due to the corona outbreak. please do something to protect the capital.”

Our answer to member:

“Thank you for reaching out to us. First of all, I am sorry to hear about your job loss due to Coronavirus. That makes things very stressful and we hope that you will recover from this asap. 

Regarding the Ultima performance: it is important to realize that although the trading system has an expected win rate on the EUR/USD 15min chart of 65%. BUT this does not mean that both winning and losing streaks do not occur. Trading entails high risk where the capital will fluctuate up and down a lot and regularly. It’s not the same as investing in a hedge fund and seeing the index value go up or down 1-3% every year. Because of the volatility, traders must only risk capital that they can actually afford to lose. They should certainly only risk a part of their savings and never ever loan money for trading. I am scared that your situation is already a bad start. You mentioned that you took a loan to have trading capital. This is unfortunately not the right way to start, I’m sorry to tell you but it’s the truth. 

Second point is this: the main goal of the EA is to build the capital. It is possible to risk small amounts. For instance, you could risk only 0.5% on the EUR/USD 15 min chart and the expected draw-down back on 2.5 years of back-testing would be small: 7.02%. You mentioned that you are trading many instruments and with high risk. This is an incorrect way of using the EA. We recommend only trading the Ultima EA with 1 pair and 1 time frame if you are using high risk like 3% or 5% per setup. The best is to trade the EUR/USD 15min chart and/or GBP/USD 60 min chart because we completed the most live trading and back-testing on these 2 combinations.

Last but not least: we do not change any setups or parameters of the EA. If you are using it in a reasonable way, then the rules are traded in the exact same way each trade, each day and each month. We do not intervene because this upsets the long-term performance. So we cannot “control the system to protect the capital”. The best way to reduce draw-downs is to limit the risk and instruments traded.

Personally, if not losing the capital was very important to me, I would risk only on EUR/USD 15min, perhaps 1% risk per setup. And perhaps add GBP/USD with maybe another 1% risk per setup. Although it’s even better to have 1 separate account for each time frame and currency pair combination.”

Thank you and good trading,
Chris Svorcik
Nenad Kerkez
Mislav Nikolic

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