So this is the question: What is Maximum, Absolute, and Relative Drawdown?
Absolute Drawdown Definition
The absolute drawdown refers to the sum difference between the initial capital risked and a minimal point below that level. This measures the amount of initial risk involved in the investment. The absolute drawdown shows how big is loss compared to the initial deposit during the trading. If the absolute drawdown value is 0, for example, this means that no capital was at risk.
Formula: Absolute Drawdown = Initial Deposit – Minimal Equity
Absolute drawdown forex example
As we can see the distance from $10 000 till $7000 is $ 3000 and it is the distance from the initial balance till value below the initial balance.
Absolute drawdown vs. maximum drawdown vs. relative drawdown
Drawdown, in its most basic sense, refers to the relative risk involved with a certain securities investment.
When faced with any investment decision, it would be wise for investors to consult as many and as varied a number of indices as possible before making that purchase or sell. One of the most critical sets of indicators is the general capital trend associated with security.
In this article, we will explain the concepts of maximum, absolute, and relative drawdown as those terms relate to securities trading.
In its simplest sense, the drawdown refers to just how much you could lose with a certain investment thus it makes it a relatively strong indicator of the overall risk of a security.
For example, if you risk $100 and lose $50 your drawdown is 50% because you have lost half of the value of your initial investment. To put it in the simplest terms, the drawdown is the difference between a high in the capital and a low point in the capital value.
The drawdown is the difference between maxima and minima on your Forex chart. This measures the amount of risk-loss involved in your proposed security trade. This number is further divided into maximum drawdown and absolute drawdown. We will explain those terms now.
It is important to understand that draw-down is important when you need to choose PAMM provider or to choose Zulutrade signal provider
Absolute drawdown vs. maximum drawdown
The maximum drawdown refers to the difference between a local max and the next minimum in your chart. This spread can show you potential profit value locked in the trading pair you have selected. If the maximum drawdown is higher than the profit potential of the currency pair, it might not be an investment that you want to consider. One of the most central strategies that traders use to guide them when it comes to this number is determining a ratio that the trader is comfortable with and avoiding trading pairs that vary wildly from that dynamic.
Maximal Drawdown = Maximum distance (Maximal Peak – next Minimal Peak)
SO we need to find the highest high till lowest low in trading balance $16000 – $7000 = $ 9000.
Absolute drawdown vs. Relative drawdown
Relative drawdown is the maximal drawdown percentage shows the ratio between the maximal drawdown and the value of respective local upper extremum (of equity)
Relative Drawdown = MaxDrawDown % = Max Drawdown / its MaxPeak * 100%
Conclusion
Forex trading often relies upon keen intuition and interpretation when it comes to charts and data as relating to the drawdown. Because of its highly volatile nature – or its tendency towards wide swings in some currency pairs – having a keen sense of risk is often the most powerful tool an investor has in their arsenal.
Most important thing is to measure Maximum Equity Drawdown because this is the most important criterion when we want to measure a good portfolio. If we look only balance, a lot of traders who do not put stop-loss or use wide stop loss will avoid showing real equity drawdown which can bring huge problems to investors or traders’ minds. The worst thing is when the trader thinks that he has excellent strategy and strategy is risky because of the huge equity drawdown.
Absolute drawdown is an excellent measure when we want to see our performance in the first months of trading and when we compare with initial balance but for long term portfolio analysis maximum and relative drawdown are much better solutions.
