This is why investors watch drawdown keenly and change trading strategies when things threaten to get out of hand.
Drawdowns present a risk to investors in terms of how much effort or changes in prices are required to overcome them or return to the initial peak. Your portfolio may have returned a profit of 25%, but during the same period, you have suffered a drawdown of 16.7%. Your account is still profitable ($25,000 in profits from the initial capital of $100,000), but you have also suffered a drawdown ($25,000 from the peak of $150,000).
#CAPITAL DRAWDOWN SERIES#
After that, you experience a series of losing trades that leave your account with $125,000. Consider this: You have a $100,000 account which you grow to $150,000. It is possible to have an overall profitable portfolio but still suffer a drawdown. A drawdown is simply the movement from a peak to a trough, whereas traders consider a loss relative to the amount of the initially deposited amount as capital. It is still important to understand that a drawdown is not a loss. A trough cannot be defined until a new peak is reached. Where Pmin = Historical low (trough) Pmax = Historical high (peak)ĭrawdowns refer to the decline of capital in a trader’s account, or more specifically, the movement from a particular peak to a particular trough. Thus, the formula for calculating drawdown as a percentage is as follows: Drawdown (DD) % = ((Pmax – Pmin) / Pmax)) * 100 Drawdown can be expressed in dollar amounts (as above) or as a percentage. Drawdown is measured over a specified period, between two distinct dates. Now, the drawdown is calculated from the peak that your account reached ($120,000) and not from your initial capital ($100,000). Let’s say that the volatility sees your account dip to $90,000, but a previous uptrend pushed your account to peak at $120,000. Your account is likely to witness whipsaws as share prices of the underlying stocks fluctuate in the market. Tech stocks are known to be particularly volatile, and this will be reflected in your portfolio as well. Consider this: You invest a substantial amount of money, $100,000, in a portfolio of tech stocks such as Facebook, Google, Twitter and Apple. In financial trading, a drawdown refers to how much an account has fallen from its peak to its trough in terms of the capital or investment amount. This is why analysing drawdowns is very important for any trader. But being too patient can also have its downsides, which is why it is important to understand the various dynamics and variables that can signal to you when enough is enough. Any trader will have learnt that patience is one of the most important attributes to have in the market.
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