Investing > Drawdown in Forex Explained

Drawdown in Forex Explained

No one likes to lose. Find out what to do when it happens to you.

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Updated January 10, 2022

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

Don’t you wish you could win all the time?

Me too.

Just imagine it—every trade goes exactly the way you planned, with profits soaring and a stream of new cars suddenly appearing in the driveway.

Of course, that isn’t always possible. 😉

If you’re experiencing losses in your forex trading, don’t worry, it’s more common than not (especially for beginners). Even very profitable traders have periods of losses—or drawdowns—in their trading. The best poker player doesn’t win every single hand. 

It’s important to understand drawdown and how to manage it in your portfolio, especially as volatile worldwide economic conditions have experts warning of a bumpy period coming up. This article will help you learn how to analyze drawdown and how to learn from it—to make your entire portfolio stronger.

Let’s jump in—you’ve got this!

What you’ll learn
  • What is Drawdown in Forex?
  • What We Learn from Drawdown
  • Types of Drawdowns
  • Drawdown: What to Do
  • What Makes Drawdown Worse
  • Avoid Drawdown Altogether
  • Forex Drawdown: FAQs
  • Get Started with a Forex Broker

What is Drawdown in Forex? 🔎

Drawdown can mean various things in finance. For example, in banking, drawdown refers to accessing credit or savings—for example, when you hear about the Massachusetts savings drawdown, that refers to their governor taking $1.6 billion from the state’s savings. Or, in the case of the U.S. Treasury’s cash drawdown, that refers to them running a $1.6 trillion account at the Federal Reserve.

In forex specifically, drawdown refers to a reduction of equity in your portfolio. No matter what trading strategies you use for forex, a drawdown is bound to happen sooner or later. Whenever your overall capital is reduced in the forex market, you are experiencing a drawdown. 

But don’t give up on forex trading just yet—a drawdown can still be part of a profitable trade in the long run. You just need to figure out whether you can withstand the drawdown and whether you believe your pair will become profitable again. First, let’s go over how you can calculate your drawdown. 

How is Forex Drawdown Calculated? ➗

You can calculate your drawdown by first identifying a peak and a trough in your capital. During a drawdown, your trading account might look something like this: 

This image is an illustration of a drawdown.
A common drawdown in forex trading.

The high point is called the “peak,” and the low point is called the “trough.” If you subtract the trough from the peak, you will know your drawdown. Usually, you would refer to this as a percentage of your overall portfolio. 

For example, say you have a trading portfolio of $50,000. After a bad trade or a losing streak, your equity drops down to $40,000. This would be a $10,000 drawdown. You could also refer to it as a 20% drawdown, because $10,000 is 20% of $50,000. 

What Forex Drawdown Teaches You 👩‍🏫

While drawdowns are never fun, they give you valuable information about the overall health of your portfolio. Even if you don’t like when your dog pukes in your living room, it still tells you who’s getting into your pantry in the middle of the night. At least in forex you don’t have to scrub the carpet!

Drawdowns can indicate whether your forex system is going to work in the long-term. You might discover that you need to trade forex at better times, or that your risk management strategies aren’t what you need them to be. Your drawdown will show you how long you can survive in the market, as larger drawdowns make your position less defendable.

Loss of Trading CapitalGain to Recover Loss
10%11%
20%25%
30%42%
40%66%
50%100%
60%150%
90%900%

As you can see from this table, you have to work extremely hard to recover your losses from a 50% drawdown. You will need to pull off a 100% profit on your remaining capital just to get back to breaking even. 

Some traders will react to a blow like this by trading aggressively—but this is almost never the best option! As we tell even beginning forex traders, making trades based on emotion and stress instead of logic and strategy never goes well. Some traders will start using too much leverage to try to recover their position, which can result in even bigger losses. 

The best way to respond to forex drawdown is to readjust your system and rely on logical strategies for risk management. It may not be possible for you to break even when you experience a major drawdown—but you can at least mitigate your losses and keep yourself from digging an even bigger hole. 

You might be experiencing a loss because you made a trade that was clearly bad—now you’ll know better next time. You might have missed an important piece of economic news, like China’s foreign exchange reserves falling $5.6 billion in February. There are plenty of reasons a drawdown can happen, and sometimes it’s best to accept the loss and adjust your strategy going forward. 

Types of Drawdowns 🗃

There are a few types of drawdown in forex, and it’s important to identify what your calculations actually mean. In general, you will calculate absolute drawdown, maximum drawdown, or relative drawdown. 

Absolute Drawdown ⚡️

Absolute drawdown uses your initial capital as a reference point. Say you deposit $50,000. Your portfolio may then rise to $60,000—that would be called your “equity peak.” Then, your portfolio goes down to $40,000—this would be called your “minimal equity,” as it refers to the lowest point your portfolio goes.

Your equity peak doesn’t actually factor into the calculation for absolute drawdown. Absolute drawdown is your initial deposit minus your minimal equity. In this example, that would be $50,000 – $40,000 = $10,000. Your absolute drawdown is thus $10,000. 

Maximum Drawdown ☝️

Maximum drawdown uses your equity peak instead of your initial deposit to calculate your loss. Using the same example as above, your equity peak is $60,000, and your minimal equity is $40,000. Your maximum drawdown is your maximum peak minus your minimal equity. In this case, your maximum drawdown would be $20,000. 

When you calculate absolute drawdown, you are seeing how much hard cash you actually lost—you had $50,000, and now you have $40,000. Maximum drawdown is a little more theoretical—it calculates from your highest worth at a particular point. This means it shows your loss compared to how much cash you could have had, not how much cash you actually had.

Relative Drawdown ⚖️

Ready for some more math? We know you are! Don’t worry, this is the last equation we’re going to throw at you. 

Relative drawdown is also known as the maximum drawdown percentage. Often, you’ll see a drawdown presented as a percentage of your portfolio, as we noted above. To calculate your relative drawdown, divide your maximum drawdown by its maximum peak, and then multiply by one hundred.

In the above example, your maximum drawdown is $20,000, and your maximum peak is $60,000. Divide 20,000/60,000, and you get 0.333. Then, multiply by 100 to arrive at 33.3%. This shows that your drawdown cost 33.3% of your portfolio value. 

And that’s it—the math is officially over! You were a champ. 

How to Control a Forex Drawdown in 5 Steps 🎛

Everyone experiences drawdowns—but not everyone deals with them in the same way. How you react to a losing streak will define what kind of trader you will be and whether you will have success in the long-term. The important thing in experiencing a drawdown is to keep your entire portfolio from crashing and burning. 

Step 1: Control Your Emotions 🥶

We can’t emphasize this enough: do not make emotional trading decisions. We know that can be difficult when you’re experiencing losses. Who wouldn’t want to tear their hair out when their portfolio dips 20%? But emotions like fear and anger will only lead you to make risky, uninformed trades. 

Take a deep breath. Go for a walk. Meditate, journal, take a bath, get on that self-care ish. Don’t make any trades until you can genuinely care about all those squiggly lines on the screen. Don’t make any trades until you can make it through a full article about how the stimulus will affect the dollar, or why Swiss traders have started investing more. Once you’ve got your head screwed on straight, you can start trading again.

Step 2: Lower Your Risk ✅

A drawdown is a great time to analyze your risk across your portfolio. If you had a losing streak of 20 trades, what would happen? To find out, take the percentage you risk in every trade and multiply it by 20. If your answer is over 100, that means you would lose your entire portfolio in a losing streak of 20 trades—and that risk is too high. 

Hopefully, you will never experience a losing streak of this magnitude, but every trader does experience a series of losses at some point. You want to make sure that your portfolio can survive downturns and bad luck. 

Every trader determines their own risk tolerance—so ultimately, how much to risk per trade is a personal decision for you. However, many traders will risk less than 1% of their portfolio on any given trade. Some will go as high as 2-3%—this depends on your tolerance for risk and the state of your portfolio. The more you risk, the more severe your future drawdowns could be. 

Step 3: Reduce Risk Again If Losses Continue 📉

Some traders want to increase their risk to make back their losses, taking on irresponsible amounts of leverage to get back to where they started. This is called “revenge trading,” and it almost never goes well. This is emotional trading that is motivated by desperation instead of logical decision-making. 

Instead, we recommend reducing your risk as much as possible if you continue to experience losses. This will help you keep your portfolio out of a downward spiral. When your losses stop, you can return your risk per trade to your usual level and start building it back up. 

💰 Looking to avoid high fees and commissions? The top forex brokers offer the best prices for beginners and pros alike.

Step 4: Set a Cap 🧢

Setting a drawdown cap can help you be more intentional with your trades and prevent a crash and burn. Essentially, this strategy means stopping yourself from trading if you hit a certain drawdown for the month.

For example, let’s say you risk 2% of your portfolio per trade. You might want to set a cap where you stop trading when you reach a 10% drawdown for the month. This will force you to be very intentional about your positions. You can also change this strategy to work best for you: you can set caps by week instead of by month, or otherwise modify it to work best for your strategy. 

It can be really difficult to pull yourself out of a bad situation. But if the alternative is making emotional, high-risk trades, we certainly recommend the pause. 

Step 5: Walk Away 🏃‍♂️💨

This is the hardest step of all—and we only recommend doing it when it’s absolutely necessary. Sometimes, trades have just gone wrong, and your portfolio is in bad shape. There isn’t always something you can do to fix it, but you can always choose not to make matters worse. 

If all else fails, you can always step away from trading and the market. If your losing streak continues even through managing your risk, it might be time to take a break. A few days or a week can make a huge difference in the market and in your trades. You might be excited by what you find when you come back. 

What Can Make a Forex Drawdown Worse? ⚠️

Think your portfolio losses have hit a low point? Hopefully, they have—but there is always further down to go if you make poor, hasty decisions. Don’t let that happen! 

Overly leveraging your trades can greatly increase your losses. Aggressive, emotional trading usually results in more losses, as the market has a way of hitting you back. 

Don’t be the poker player who stays at the table after he’s lost more money than his house is worth, sure he’s going to make himself whole—and then doubles his losses in an hour. Sometimes, you just have to accept where your portfolio is, and lower risk as much as possible. 

Avoiding a Forex Drawdown Altogether 👇

It’s not possible to completely avoid a drawdown—they happen to everyone. However, you can minimize your risk by making smart, sound decisions. You might: 

  • Try a new trading strategy. 
  • Set up news alerts to predict market volatility.
  • Reduce your risk per trade.
  • Minimize leveraged trades. 

If you’re looking for more advanced risk management strategies, you can look into hedging forex trades—though be aware some forms of hedging are not legal in the United States.

You can also keep the markets in your crosshairs by using some of the top forex trading apps that can keep you plugged in and trading as economic or political news hits. After all, cloud technology is expected to account for the bulk of forex trading by 2025.

Conclusion

If you experience a drawdown in forex, don’t be down—it happens even to the best traders. Just make sure you keep a level head and make positive trading decisions that can keep you from crashing and burning.

And no matter, just remember: You’ve got this! 

Forex Drawdown: FAQs

  • What is the Maximum Forex Drawdown?

    Maximum drawdown refers to the difference between your portfolio’s highest value and its lowest value.

  • How Do You Deal with Drawdown?

    To deal with drawdown, minimize your risk per trade to keep your losses from expanding. Consider adjusting your strategy going forward. Don’t start trading emotionally or aggressively to try to get back to where you were.

  • Can I Claim Forex Losses?

    You can claim forex losses on your taxes, but the IRS limits the amount of loss you can deduct in a given year. You can only deduct up to $3,000 in losses each annually but you can carry over the rest of your losses to the next year if you want.

Get Started with a Forex Broker

Fees
Average spread EUR/USD standard

N/A

0.9

All-in cost EUR/USD - active

N/A

0.363

Minimum initial deposit

$0

$250

General
Total currency pairs

105

93

Demo account?
Social / copy trading?
Rating
Fees
Average spread EUR/USD standard

0.9

0.6

All-in cost EUR/USD - active

0.363

0.6

Minimum initial deposit

$250

$10,000

General
Total currency pairs

93

182

Demo account?
Social / copy trading?
Rating
Fees

Average spread EUR/USD standard

N/A

0.9

0.6

All-in cost EUR/USD - active

N/A

0.363

0.6

Minimum initial deposit

$0

$250

$10,000

General

Total currency pairs

105

93

182

Demo account?

Social / copy trading?

All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.

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