Drawdown: How Much is too Much?
Drawdown is the measure of the decline from a historical equity peak in your account. It is also the number one reason why people stop trading. Often, after experiencing a decline in equity greater than the futures trader prepared themselves for, shear panic sets in and they shut down their trading.
To calculate drawdown in the chart above, simply subtract an equity low from a preceeding equity high and divide the difference by the high. For example, at point B in the chart, the recent high (VAMI) is 3535 and the low equity value is 3038. The equity decline would be (3535-3038) / 3535 or 14.1%. At point A in the chart, the equity decline would be (2016-1525) / 2016 or 24.4%.
Controlling or managing large equity declines is obviously crucial to becoming a long term, profitable futures trader. Unfortunately, drawdown in commodity trading is often not stressed enough, or worse, misrepresented.
The right hand column is the percent gain needed to get back to the break-even level after experiencing an equity decline in the left hand column.
If your account experiences a large equity decline, the return to a new equity peak becomes quite challenging. For example a 40% decline requires a 67% return to get back to even.
After experiencing a 40% decline, it would take you close to 2.5 years compounding at an average rate of return of 25% to recover your original investment.
At a 60% decline, it would take you over 4 years at a 25% compounded rate of return to recover.
As you know, there is no guarantee of a 25% return. At an 8% return it would take you almost 7 years to get back to your starting point.
Obviously, avoiding large equity declines is crucial to long term trading success. A more reasonable expectation for return, and managing risk within an acceptable recovery period, makes much better sense than working from a deficit. Successful futures traders take small, measured risks and focus on controlling their exposure to the markets. See how at Commodity Trading Solutions we use advanced money and risk management tactics to manage the drawdown in our strategies.
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CFTC REQUIRED RISK DISCLOSURE
Futures and options trading involve substantial risk. The valuation of futures and options may fluctuate, and as a result, clients may lose more than their original investment. In no event should the content of this website be construed as an express or an implied promise, guarantee or implication by or from Commodity Trading Solutions, LLC that you will profit or that losses can or will be limited in any manner whatsoever. Past performance is not necessarily indicative of future results. Information provided on this website is intended solely for informative purposes and is obtained from sources believed to be reliable. Information is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted.
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