Drawdown in Forex Trading

The drawdown is a very important property of any Forex trading report, strategy or expert advisor. The drawdown characterizes the risk of the employed strategy. Profitability of a given strategy should always be considered in couple with the drawdown because otherwise you won’t take the risk into account and that’s a very bad thing to do. Forex is a probability-based activity and thus should be treated from the risk/reward perspective.

The drawdown is a difference between some local maximum point in your balance chart and the next following minimum point in that chart. It’s the risk amount by which your strategy can go down during a streak of losses. There are two types of drawdown that are considered to be the important properties of expert advisors (for instance, in MetaTrader platform) — absolute drawdown and maximal drawdown.

Absolute drawdown is the difference between the initial deposit and the minimal point below the deposit level during all test period. It tells you how big your loss can become compared to the initial deposit during the trading. If this value was 0 during the test, then your deposit wasn’t at risk at all.

Maximal drawdown is the maximal difference between the local maximum extremum in your equity chart and the next local minimum extremum in your equity chart. It tells you how low your strategy can go after getting some profit. It can also be called a depth of a losing streak. Generally it’s a good idea not to trade with EAs with the maximal drawdown higher than the profit. But I don’t recommend trading even with strategies or expert advisors that have maximal drawdown at levels higher than 25% of the net profit. Mind your own risk-to-reward ratio and don’t trade with EAs that don’t comply with it.

Now you know what drawdown is and how it’s calculated in Forex trading. Unfortunately, the current version of MetaTrader 4 (Build 225), the strategy tester incorrectly calculates the drawdowns, so if you are testing your EAs, it’s better to calculate both the absolute drawdown and the maximum drawdown manually.

If you have your own opinion or questions about maximal or absolute drawdown, feel free to leave it in a comment to this post.