Drawdown and maximum drawdown

Capital Management: The Art of Minimizing Drawdowns and Surviving in Trading

You already understand how proper capital management can increase your profits in the long run. But now, let’s look at the other side—what happens if you ignore capital management rules?

Drawdown: What Is It and Why Does It Matter?

Imagine you had $100,000 in your account, and then you lost $50,000. What percentage of your capital did you lose? The answer is simple—50%.

This is called a drawdown—a decrease in capital after a series of losing trades. Drawdown is calculated as the difference between the highest and lowest balance in your account over a specific period and is usually expressed as a percentage.

But here’s the key point: if you lose 50%, you need to gain 100% on your remaining balance just to break even. The larger the drawdown, the harder it is to recover.

Losing Streaks in Trading: Are You Ready for Them?

Many traders build their trading systems based on probabilities. For example, a strategy with a 70% win rate out of 100 trades sounds solid. However, this doesn’t mean that every 7 out of 10 trades will be winners. There’s a possibility that the first 30 trades could all be losses.

Question: Will there be anything left in your trading account after 30 consecutive losing trades?

If you don’t have proper risk management, the answer is likely no.

Trading is similar to poker. Even professional players face losses, but they stay in the game because they manage their capital wisely. They don’t bet their entire bankroll on a single hand and understand that the long-term outcome matters more than any single round. The same principle applies to trading: your goal is not to win every trade but to stay in the game long enough for probabilities to work in your favor.

The Depth of Drawdown: Different Traders, Different Limits

Capital management is far more complex than just a simple rule about how much to risk per trade.

✔ Different traders use different approaches to drawdown management:

• Strict risk management – for example, using stop-losses or a fixed risk percentage per trade (e.g., 1-2%).
• Flexible approach – managing a position without fixed stops but maintaining control over the overall drawdown.

✔ Drawdowns must be manageable:
The key is to avoid forced liquidation of your account. This is especially crucial if you trade:

• Futures
• Forex with leverage
• CFD contracts

Any of these instruments can quickly lead to a margin call if you don’t account for maximum drawdown.

How to Control Drawdown?

1️⃣ Limit risk per trade – for example, no more than 1-2% of the deposit on each position.
2️⃣ Control overall drawdown – if you are experiencing a series of losing trades, consider reducing position sizes or pausing trading temporarily.
3️⃣ Adapt your capital management to your strategy – not all traders use stop-losses, but every professional controls their potential losses.
4️⃣ Avoid reckless averaging – if a position is moving against you, randomly adding more trades without a plan can lead to complete financial ruin.

Conclusion

Your main goal is not just to make profits but to survive in the long run. Proper capital management allows you to endure losing streaks so you can stay in the market and eventually take advantage of your edge.

 

In the next section, we’ll explore what happens when capital management works in your favor—and the catastrophic consequences of ignoring it.