Draw-down and Maximum Draw-down - Money Management in Gold Trading
In a business in order to make profit one must learn how to manage risks. To make profits in Gold trading you need to learn about the various money management strategies discussed on this learn Gold trading website.
When it comes to Gold trading, the risks to be managed are potential losses. Using money management rules will not only protect your trading account but also make you profitable in the long run.
As Gold traders the number one risk in Gold trading is known as draw-down - this is the amount of money you have lost in your trading account on a single Gold trade transaction.
If you have $50,000 capital and you make a loss in a single transaction of $500, then your draw-down is $500 divided by $50,000 which is 1 % draw-down.
This is the total amount of money you have lost in your trading account before you start making profitable trades. For example if you have $50,000 capital and make 5 consecutive losing positions with a total of $2,500 loss before making 10 winning positions with a total of $5,000 profit. Then the draw-down is $2,500 divided by $50,000, which is 5 % maximum draw-down.
Draw Down in the example above is $442.82 (4.4%)
Maximum Draw Down is $1,499.39 (13.56%)
To learn how to generate the above trading reports using MetaTrader 4 platform: You can search on how to generate trading reports on MT4 Tutorials.
Money Management Methods
The example below shows the difference between risking a small percentage of your trading capital compared to risking a higher percentage of you trading capital. Good trading principles require you as an investor or a trader not to risk more than 2% of your total account equity on any one single trade.
Percent Risk Method
2% and 10% Risk Rule - Gold Trading Money Management Rules
In trading, there is a big difference between risking 2% of your account equity compared to risking 10% of your account equity on a single trade transaction.
If you happened to go through a losing streak when trading Gold and lost only 20 trades in a row, you would have gone from starting balance of $50,000 to having only $6,750 left in your trading account if you risked 10% on each trade transaction. You would have lost over 87.5% of your account equity.
However, if you risked only 2% when placing the trades, you would still have had $34,055 which is only a 32% loss of your total account equity.
This is why it is best to use the 2% risk management strategy
The difference between risking 2% and 10% is that if you risked 2% per every trade you would still have $34,055 after 20 losing trades.
However, if you risked 10% per trade you would only have $32,805 after only 5 losing trades and that is less than what you would have had if you risked only 2% of your account and lost all 20 trades.
The point is that you want to setup your money management rules so that when you do have a loss making period, you will still have enough capital to trade the next time.
If you lost 87.5% of your account capital you would have to make 640% profit on your remaining balance to get back to break even.
As when compared to if you lost 32% of your trading capital you would have to make 47% profit on your remaining balance to get back to break even. To compare this with the above example, 47% maximum draw down is much easier to breakeven than 640% maximum draw down is.
The chart below shows what percentage of your account equity you would have to make to get back to breakeven if you were to lose a certain percentage of your trading capital.
Concept of Break Even
Trading Account Equity and Concept of Break Even
At 50% draw down, a trader would have to earn 100% on their remaining capital - a feat accomplished by less than 5% of all online traders worldwide - just to break even on an account with a 50% loss.
At 80% draw down, a trader must quadruple their account equity just to bring it back to its original equity. This is what is known as "break even" i.e. get back to your original account balance that you deposited after making a draw down.
The more you lose, the harder it is to make it back to your original account equity.
This is the reason why as a trader you should do everything you can to PROTECT your account equity. Do not accept to lose more than 2% of your equity on any 1 single trade transaction.
Money management is about only risking a small percentage of your trading capital in each transaction so that you can survive your losing streaks and avoid a large draw-down on your trading account.
In trading, traders use stop loss orders which are placed in order to minimize losses. Controlling risks involves putting a stop loss order after opening an order.
Effective Risk Management
Effective risk management requires controlling all the trading risks. A trader should come up with a clear money management system and a trading plan. To be in Gold trading business or any other business you must make decisions involving some risk. All factors should be measured to keep risk to a minimum when trading Gold online and make sure you use the above tips on this article.