Zulutrade: Understanding Drawdown

Understanding Drawdown and how it affects your account will help you a lot to avoid losing your precious capital. Zulutrade's "Max DD%" maybe the most important tool you can use to analyze signal providers in Zulutrade.

What is Drawdown?

Maximum Drawdown is the largest peak to valley equity drawdown in the signal provider’s trade history. A high maximum drawdown means that open trades experience huge paper losses before they are closed. So even if most trades ultimately end up as winners, they likely had to go through an extended drawdown before returning to profitability. Huge drawdowns can lead to Margin calls, where the positions which do not have sufficient deposit will be simply closed by the broker. (You don't want a margin call to happen in your account!)

Zulutrade shows Maximum Drawdown as a percentage and is computed from the number of pips against the total profit.

 

 To better illustrate let's take a look at a signal provider with a very EXTREME drawdown:

Maximum Drawdown is shown above as the red line. As you can see this signal provider experienced huge paper losses and for an extended period! This means that the trades with huge losses are left open in your account. If your account does not have sufficient capital, your account will suffer a margin call and the open positions with huge paper losses will be automatically be closed by your broker. Take a look at this signal provider's Equity curve below:

We definitely want to avoid this signal provider! The account equity reached a low of -3000 pips, has an overall profit of 1 pip, and has open positions of -2,178 pips! The warning from Zulutrade says it all!

What to do:

Always check the Max DD% of the signal provider at the Performance tab and at each signal provider's page. The lower the Max DD%, the better. The next thing to check is the Trading History. I find that using the Excel format of the trading history is better as you can easily highlight huge drawdowns. 

Look for trades with large negative drawdowns. This indicates the degree of risk taken by the signal provider, and whether the signal provider is leaving trades open too long or using very wide stops. 

When dealing with drawdowns in your automated trading account, the maximum drawdown is a good measure of the amount of negative equity you can expect. However don't trash a perfectly good trading system because of drawdown, as long as those losses are within the amount of risk indicated by the maximum drawdown and the equity curve.

Related Posts: Zulutrade: Using Stop loss and Limit Orders

Posted in: Choosing your Signal Providers, Risk Management