Drawdowns are not all created equal! Let’s explore some of the various types:
END OF DAY DRAWDOWN
This is likely how you’d monitor your own trading account, trailing the draw down based upon your account balance at the end of each trading day. For example on a “$30k” account with $1500 drawdown:
- Day 1: You make $500 profit. Your account balance is $30,500 and the minimum account balance before failure is $29,000. Your balance must not drop below this.
- Day 2: You lose $200. Your account balance is $30,200 and the minimum balance remains $29,000. You’ve reduced the available draw down by $200 – you have $1300 to play with.
- Day 3: You make $400. Your account balance is now $30,600. Minimum account balance is $29,100 and you’re back to having $1500 to play with.
INTRA-DAY DRAWDOWN
Some evaluation programs trail the draw down based upon the trades that you take during the day:
- Trade #1: You make $500 profit. Your account balance is $30,500 and the minimum account balance before failure is $29,000. Your balance must not drop below this.
- Trade #2: You lose $200. Your account balance is $30,300 and the minimum balance remains $29,000. You’ve reduced the available draw down by $200 – you have $1300 to play with.
- Trade #3: You make $50. Your account balance is now $30,350. Minimum account balance remains at $29,000 and you to have $1350 to play with.
So you can see that losing trades or losing days can start to make your evaluation progress harder.
Evaluation programs using either of these two approaches typically combine them with a daily loss limit. Intra-day drawdown most likely monitors an open trade in real time too. If an open position’s unrealized loss results in the intra-day drawdown being breached, then the drawdown rule will most likely be triggered.
There’s an even tougher variation of trailing draw down however which can be brutal…
INTRA-DAY DRAWDOWN BASED ON UNREALIZED P&L
This is pretty horrible and it’s not really representative of how you’d monitor your own trading account in reality. It is however a tough rule that helps people fail evaluations… Let’s see it in action:
- Trade #1: You make $500 profit. Your account balance is $30,500 and the minimum account balance before failure is $29,000. Your balance must not drop below this.
- Trade #2: You had $100 open profit on the position and your trailing stop closed you out with $50 profit. Your account balance is $30,550 but the trailing draw down has increased by the maximum open profit on this trade ($100) and is now $29,100. Your available draw down has actually decreased by $50 to $1450 even though your account balance has gone up!
- Trade #3: Once again you had $100 open profit but you closed at a loss of -$100. Your account balance is now $30,450, but the trailing draw down has gone up again by the position’s maximum profit ($100). Your drawdown is now $29,200 and you’re left with $1250 available draw down.
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Even though you’re $450 in profit on the account, because you didn’t close even trade at its maximum profit, your available drawdown has reduced from $1500 to $1250!
With this approach, you’re penalized for not taking the maximum available profit on each trade. Losing trades and losing days can really start to squeeze your “working capital” – the available draw down on your account.
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STAY AWARE
It’s important to be aware that the rules between evaluation tests and “funded” accounts can differ too! Some evaluations will have end of day draw down, but once you’re in a “funded” account, the rules could change to intra-day drawdown based on unrealized P&L (that may stop trailing upon reaching a specific level of profit in the account).
