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What is ROI in Trading?

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The concept of ROI can be applied to many areas of finance and trading, such as stocks and commodities. Investors calculate their ROI by taking the amount they have earned from an investment minus the cost of investing (including taxes), divided by the initial amount invested. The result is then expressed as a percentage. In other words, it is a measure used to determine how much money has been made compared to what was spent.

It is important to remember that although higher returns usually indicate better investments, there are no guarantees regarding trading. Risk assessments should always be undertaken before any investments are made, and diversification measures should also be taken to minimize losses when possible.

In addition to calculating profits and losses resulting from specific investments, traders may also use ROI as part of their strategy for how much capital they will allocate in different areas at any given time. By understanding their ROI over extended periods and other factors such as risk appetite and market conditions, traders can optimize their portfolio allocation for optimal returns on their investments without taking on more risk than desired.

Understanding ROI

The financial world is riddled with jargon and multiple confusing words. Without understanding these, surviving in a world filled with bankers, investors, and complex corporate environments may not be easy.

What is ROI?

Return on Investment or ROI  represents an investment’s benefit (or return) divided by the investment cost. ROI, as a financial ratio, evaluates the profitability of an investment. Return on Investment can be expressed as a ratio or percentage—for example, the more significant the percentage, the better the investment.

It provides an easily usable formula that has many practical uses. For example, one can compare the Return on Investment from a range of not generally compared assets. Therefore, one could compare the stock market’s performance with a new niche start-up by merely plugging the correct financials into the Return on Investment equation.

What is ROI in trading?


ROI in trading represents the amount of money gained or lost on an investment relative to the amount invested. If the trader invested $1000 in his account, he made a $400 profit, then the return on investment in trading would be $400/$1000=0.4 or 40%.

Return on investment (ROI) in trading is an essential concept, as it helps traders assess the effectiveness of their assets. It is a metric that measures the total amount of money gained or lost on an investment relative to the amount initially invested. For example, if you invest $1000 into a trading account and make a $400 profit, your return on investment in trading would be $400/$1000=0.4 or 40%.

Return on investment equation

To calculate this, the amount earned is divided by the cost of the investment. The result is expressed as the Return on Investment ratio. Mathematically, the Return on Investment equation goes as follows:

ROI = (earnings from the investment – the cost of acquisition) / cost of investment

Sample investment return: Next, one must consider calculating a Return on Investment practically. To this end, a return on investment example should suffice: John invested $1000 in Nice Shoe Inc in 2010. Today, he wishes to sell those shares, and he sells them for a total of $1400. If he wanted to know his return on investment, John would first have to calculate his profits. This can be done by subtracting investment value and the cost of investment: $1400 – $1000 = $400. Next, the gain is divided to get the investment of $400/$1000 = 40%. Therefore, John’s return on investment is 40%.
These equations may be made much simpler using online return on investment calculators. This can make life simpler when comparing multiple investment opportunities simultaneously, allowing for a more straightforward path to seeing the opportunity costs associated with a respective business path.

Forex ROI calculator:

 

How to calculate the rate of return on investment in excel?

We can calculate return on investment in an excel sheet if we put the equation as a formula. You can download the return on investment (ROI) excel template.

 

What is a reasonable average rate of return on investments?

The reasonable average return rate on investment differs from industry to industry. Globally, an excellent average rate of return on assets is above 50%.
Generally, any value that comes out of the Return on Investment equation as positive is considered a good return. Nonetheless, the importance remains on evaluating all options so that the investment chosen outweighs its associated opportunity cost. The opportunity cost is the next best option forgone with the purchase of any good, service, or asset.
Consider this: John (from the example earlier) had the opportunity of purchasing shares in Nice Shirts Inc. For the same $1000 in investment, his Return on Investment would have equated to 50% over the same period. Therefore, John’s opportunity cost was higher than his profit from buying shares in Nice Shoes, Inc.
From this, one can see that opportunity cost plays a vital role in decision-making. A comprehensive Return of Investment analysis may help dramatically aid this because, as stated earlier, the equation provides a reasonable basis for numerical comparison.

 

What is a good return on investment in forex trading?

The excellent return on investment in forex trading is 20% annually. Active investor in stocks or forex is usually happy with a 15-20% annual return.

What has been considered a good return on investment is hard to tell. Each industry has its average ROI. For example, marketing and advertising for every $1 invested will bring you at least $2. On another side, real estate and stocks can get you a cumulative high profit, but ROI is much smaller. See the image below:
What is good return on investment

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Limitations of the Return on Investment Analysis

Return on Investment is a profitability ratio. This means it is supposed to aid in any investment opportunity’s decision-making. However, to play a proper role in that situation, it is critical to establish that it has limits. The equation does not consider the time between the initial investment and the profit received. So, it may put assets that have different Rates of Return in the same category.

For example, the Return on Investment equation will say two 20% Returns on Investments are the same even though the first investment may have achieved this in 6 months and the second in 2 years. Therefore, the Return on Investment analysis is insufficient and must be used alongside other crucial profitability measures. Such measures provide a better basis with which to make an investment decision.

Examples of such calculations include the Present Net Value (NPV) and the Internal Rate of Return (IRR). These are not comprehensive, and further research is suggested before making critical decisions.
Furthermore, the Return on Investment analysis only provides historical data. This means that it cannot be a predictor of what an investment may do in the future. However, specific implications may be drawn from this.

Criticisms of evaluating performance based on ROI include:

  • Reject investment opportunities that are profitable for the company but negatively impact a manager’s ROI.
  • Be put in charge of a business segment that includes committed costs over which a manager has no control.
  • Take actions that increase ROI in the short run at the expense of long-term performance.

In every country, ROI is the most commonly used financial performance measure. Return on investment calculation allows managers of one organization to compare performance with that of other organizations. To increase the return on investment (ROI), the company must increase sales, decrease operating expenses, or increase unit sales.

Which investment offers the best combination of low risk and high return?

Investments like preferred stocks, utility stocks, fixed annuities, and brokered CFDs offer the best combination of low risk and high return.
Stocks are typically high risk and high return, while bonds (especially government-secured bonds) are low risk and low return.

Stocks are typically high risk and high return; as an investment, bonds are less risky than stocks but generally have a lower rate of return. On the other side, one of the benefits of mutual funds is that their diversification reduces risk. The answer is: both can be risky, but average stock investing is more complex than average mutual fund investment. Most mutual funds can achieve a 5-7% ROI annually.

How to Calculate an Annual Return With Stock Prices

As same as we calculate ROI for any other business, ROI = (gain from the investment – the cost of acquisition) / cost of investment.

Simple Return = (Current Price-Purchase Price) / Purchase Price
Annual Return = (Simple Return +1) ^ (1 / Years Held)-1

or if you have dividends:

Simple Dividend-Adjusted Return = (Current Stock Price-Dividend-Adjusted Stock Purchase Price) / Dividend-Adjusted Stock Purchase Price.
Annual Dividend-Adjusted Return = (Simple Dividend-Adjusted Return +1) ^ (1 / Years Held)-1

 

The Future of ROI in Trading

This is a question we have when we talk about investing and ROI. Risk increases if the loss exceeds the amount invested, even if the probability remains unchanged. SO higher risk corresponds to higher returns, and lower risk equals lower returns. Return on investment can not be the only thing we are looking for when we invest our money—ROI and risk need to study together.

Recent times have seen the advent of the Social Return on Investments, a measurement system that considers the Triple Bottom Line: social, environmental, and economic factors. SROI helps the management of companies understand the scope of their decisions in a broader sense than just monetary policy.

Moreover, the Return on Investment analysis can act as an alarm bell, as the equation’s harmful products should see the immediate withdrawal of capital from the investment.

Overall, Return on Investment (ROI) in trading can provide valuable insights into how effective trades have been over time and help inform future strategies for capital deployment across different asset classes. By understanding its principles, investors can make smarter decisions when deciding where to allocate their capital to maximize returns while minimizing risk exposure.

What is Forex Trading and How Does it Work?

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Foreign exchange trading, also known as forex trading, is a global market where participants trade one currency for another. Forex trading is the simultaneous buying of one currency and selling of another. Foreign exchange traders aim to make money from fluctuations in the exchange rates between currencies. Foreign exchange markets exist wherever one currency is traded for another and are always active, with prices constantly changing due to economic and political factors.

Forex trading or foreign exchange trading is a business based on speculating on the fluctuating values of currencies between two countries. The trading goal is to profit by converting one country’s currency into another country’s currency. Forex trading includes all aspects of buying, selling, and exchanging currencies at current or determined prices.

how forex works

The foreign exchange market consists of two main types of participants: speculators and hedgers. Speculators are typically investors who buy or sell a currency to profit from its movements on the open market. Hedgers are generally large corporations or institutions that need to protect their investments from potential losses due to adverse changes in exchange rates.

Forex trades occur over-the-counter (OTC), meaning they occur directly between two parties that have agreed upon the terms of the transaction rather than through an organized marketplace like a stock exchange. Trades take place all over the world, 24 hours a day during weekdays because there is always some part of the world’s financial markets open at any given time.

forex market outlook flowchart

Each country has its currency, and when a country’s currency is traded or exchanged with the currency of a foreign country, this is called foreign exchange (forex trading). Investors and traders interested in Understanding forex should know that the forex brokers decide the currency pairs. These brokers may not offer a match for the currency pair a trader is interested in.

Trading activity is driven by four major groups: commercial banks, central banks, investment firms, and retail forex traders (individuals). Commercial banks conduct most foreign exchange transactions because they provide services such as loans and letters of credit for international businesses and receive payments from customers around the globe.

Central banks intervene in forex markets when there is an imbalance in supply and demand to stabilize their domestic economies by keeping their currencies competitively priced against other currencies. Investment firms facilitate speculative trades on behalf of their clients. At the same time, retail forex traders seek to profit from short-term price movements in individual currencies using similar strategies employed by professional traders, such as technical analysis or trend-following strategy based on technical indicators supplied by brokerages or independent data providers.

what is forex definition

Regarding executing trades, forex can be traded manually or through automated systems known as expert advisors or robots. Manual trading requires more experience with financial markets. In contrast, computerized systems require less effort. Still, they may not be as profitable if misused due to unpredictable market conditions caused by economic news releases or political events that can lead to dramatic price swings even before human reactions occur.

The primary benefit of trading forex over other asset classes is liquidity — investors can enter and exit positions quickly without having to wait for someone else to accept their offer since there will always be buyers and sellers available for each currency pair at any given time throughout global business hours regardless of market conditions outside those hours – this ensures that investors never miss out on any opportunities arising during times where they otherwise might not be able available trade manually. Additionally, brokers offer low spreads, which makes it easier for investors to reduce costs with minimal impact on profits when compared to investing in other asset classes, such as stocks or commodities, which tend to have wider bid-ask spreads making it harder for small investors who have limited capital reserves at their disposal.

In conclusion, foreign exchange trading offers many benefits, including low transaction costs, access to deep liquidity pools across different countries, and greater flexibility when choosing when to enter trades. These advantages make foreign exchange trading an attractive option for aspiring traders looking to get involved with financial markets without having too much experience or access to capital reserves required to start trading other asset classes, such as stocks or commodities, which could otherwise prove costly mistakes if done incorrectly due lack knowledge these product’s nuances risks associated them respectively.

 

Forex is the trading of currency pairs. One of the most popular currency pairs is the EUR/USD, where EUR or EURO is the European currency, and USD is the united states dollar. The forex pair’s value will increase when the Euro value increases compared to the dollar and vice versa. When the trader buys EURUSD, he believes that EUR will rise against the US dollar.

If a trader speculates that the USD value will decrease compared to the Euro, they will invest in the EUR/USD and wait. This kind of trading is called going long. If the dollar value is likely to increase, the trader will go short on the same pair. All trading is routed through forex brokers, who are intermediaries, executing the trade in the open market. Since there is no centralized market for forex trading, the rates offered by the different forex brokers may vary at any time. The forex brokers place their orders using the networks of the major banks. The orders are executed electronically within a fraction of a second after they are placed.

Forex trading is all about buying and selling currency pairs. Forex market is a network of buyers and sellers, and they transfer currency between each other at an agreed price.

For forex trading, each trader must have a forex account and basic technical and fundamental analysis knowledge. The essential advantages of foreign exchange are high liquidity, 24 hours market, and small transaction costs. Forex is a legit business where more than 5 trillion dollars each day fluctuate in the forex market. Forex trading is not a scam – it is as same as trading stocks or any other asset.

Leverage in forex trading

For most people, the primary purpose of trading forex online is to make money. Large companies may trade in forex for a purchase planned in the future or for offsetting a contract that they bagged. Retail traders hope to make money from forex trading due to the changes in the currencies they deal with. Forex brokers offer to offer traders leverage while trading. Leverage allows the trader to trade for amounts more significant than the balance in his account—the forex broker benefits from leverage since the fees will be directly proportional to the amount being traded. The forex broker collects an amount called the spread for each trade.

Leverage in forex represents the ability to make more significant positions with a smaller amount of actual trading funds using borrowed capital from the broker.

However, there are some disadvantages to using leverage. Many inexperienced traders use the maximum leverage available., They often make losses and use up all the money in their account. Hence new traders should spend some time learning forex trading and using the least amount of leverage while trading initially to reduce their losses.

The most important thing is risk in forex trading. Forex offers high leverage where traders can conduct trades in the market by using more significant sums of money than what their accounts possess.
Risk in forex trading needs to be minor, and managing risk is one of the essential jobs for each trader.

But the person would yet hold power to engage in the controlling and trading on the market with a currency in the amount of two thousand dollars. This can be dangerous because new traders may be eager to commence trading instantly with a leverage set at 50.1. But they may not give any preparation concerning the consequences that may ensue.

It sounds like a fun experience to trade with access to leverage. This can increase the chances for one to make good money. However, there is not much talk about the fact that this can also present a higher risk of devastating losses.

When someone trades at a rate of 50:1 with the sum of one thousand dollars in their account, this indicates that the person would be changing fifty thousand dollars on the market. Each pip is, therefore, worth about five dollars. When the move for the daily average about the price of a currency pair is set at 70 to 100 pips, this would mean that the average loss could equate to three hundred and fifty dollars. If one engaged in conducting a reasonably poor trade, this could result in the loss of a complete account in three days if there are normal conditions.

Is forex trading profitable?

No, forex trading is not a highly profitable business because of the high risks, low percentage of successful traders, and highly predictable market.

So when we talk about profit, 95% of traders lose their money because of high-risk trading, overtrading, and lack of risk management plan.

See Table below: loss and gain how to recover

Many new traders hold a lot of optimism, believing they could see their accounts doubling in only a few days. Yet, visiting your account undergoes many severe fluctuations can indicate that it will be difficult for your account to fold quickly. Many people commence with the assumption that they can endure this scenario. Yet, they are not often able to handle the scenario, they make grave mistakes in their forex trading efforts, and no money remains in their accounts.

Though one may not fall prey to the trap of leverage, the significant difficulty is controlling one’s emotions. One must be able to be in control of their feelings when conducting trades on the forex market because this market can be wild as a roller coaster, and it takes a solid drive to be able to accept the losses at the proper time and not make the blunder of grasping onto trades for too long a period.

How does the forex market work, in simple words?

The forex market works like one big money exchange office. Every second, some buyer buys the currency, and some other sellers sell the same currency. Because there are millions of algorithms, millions of traders, and billions of positions around the globe, forex markets do not allow some strategy becomes forever profitable.

This is the most common beginner question. Value is determined by what people are willing to pay. Forex is a zero-sum game, and when you place your order and lose money, your investment creates price value. When you buy an asset, on the other side, someone sells an asset. Buyers and sellers make price value, and that is only the most important in forex!

 

Payoff Ratio

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The payoff ratio is a key metric used to measure the success of a portfolio and is an essential factor in determining the overall profitability of investments. The payoff or profit/loss ratio is calculated by dividing the average profit per trade by the average loss per trade. But it’s a measure of how much you make on winning trades versus how much you lose on losing trades. A higher payoff ratio indicates that more profitable trades are being made, while a lower payoff ratio suggests more losses than wins in the portfolio.

The payoff ratio is an essential measure in portfolio management in the financial industry.

The payoff or profit/loss ratio is the portfolio’s average profit per trade divided by the average loss per trade. Simply put, the payoff ratio is the ratio between the size of the win and the loss’s size. If we have higher values – the portfolio performance is better.

The payoff ratio explanation video is below:

This is necessary when discussing money management (visit our article about money management and expert advisors). The payoff ratio is not the same as the Sharpe ratio (the Sharpe ratio is a measure of excess portfolio return over the risk-free rate relative to its standard deviation.)

The importance of understanding the payoff ratio cannot be overstated. It provides investors with valuable insight into their portfolio performance and can significantly impact overall profits. Knowing your payoff ratio helps identify potential areas for improvement and gives you an idea of what strategies may be more effective going forward. Additionally, it can provide insight into which trades have been most successful for your portfolio and which methods to avoid to maximize future profits.

Understanding payoff ratios also allows investors to compare their portfolios against those trading similar assets or strategies. This can enable better decision-making when choosing investments or adjusting existing ones and help them spot trends or patterns they may not have noticed before. Knowing what works best for other investors may help inform one’s own decisions, ultimately leading to improved returns in the long run.

In addition to its utility as an analytical tool, there are also several other benefits associated with using payoff ratios when analyzing portfolios:

  • The pay-off ratio metric allows you to assess risk across different positions accurately;
  • The pay-off ratio metric will enable you to quickly identify which positions should be adjusted based on recent market movements;
  • The pay-off ratio metric provides investors with an easy-to-understand metric for measuring performance;
  • The pay-off ratio metric helps you determine whether positions are underperforming or outperforming expectations;
  • The pay-off ratio metric enables investors to track their progress over time and adjust their strategy accordingly.

How to calculate the payoff ratio?

Average win = Total Gain/number of winning trades

Average loss = Total Loss/number of losing trades

Payoff ratio = Average win / Average loss = (Total Gain/number of winning trades ) / (Total Loss/number of losing trades)

Example of how we can calculate the payoff ratio for a system or portfolio:

Our system or portfolio has the following:

300 winning trades
200 losing trades
The total gain is $9000
The total loss is $8000

Then expected payoff forex ratio will be :

Average Win = Total Gain / number of winning trades = $9000 / 300 = 30
Average loss = Total Loss / number of losing trades = $8000 / 200 = 40
Pay off ratio = Average win / Average loss = 30/40 = 0,75

payoff ratio fomrula and calculation

What is a good payoff ratio? The payoff ratio above 0,8 is excellent.

About payoff ratio formula and other formulas
We use the Literature payoff ratio when we want to calculate the winning rate or win rate.

Win rate = Profit factor / (profit factor + payoff ratio)

A very similar term is Expected Payoff where

Expected Payoff = Total Net Profit / Total Number of Trades.

What payoff ratio can tell us about our portfolio?

It can tell us only about the risk-reward strategy, but it can not give an excellent explanation of our portfolio profitability.

We need to calculate average profitability per trade (APPT) or math language expectations except for this value.

Average profitability per trade = (Probability of Win * Average Win) – (Probability of Loss * Average Loss).

So let us calculate the Average profitability per trade for our case :

Three hundred winning trades mean that from 500 trades, 300 are winning. Probability of Win = 300/500 = 60%
Two hundred losing trades mean that from 500 trades, 200 are losing. Probability of loss = 200/500 = 40%
The total gain is $9000
The total loss is $8000
Average Win = Total Gain / number of winning trades = $9000 / 300 = 30
Average loss = Total Loss / number of losing trades = $8000 / 200 = 40

Average profitability per trade = (Probability of Win * Average Win) – (Probability of Loss * Average Loss) = 0.6*30 – 0.4*40 = $18 – $16 = $2

Payoff ratio vs. Profit factor

The profit factor is a better signal than the payoff ratio. The payoff ratio can be meager, and the system can be profitable. The payoff ratio without a win rate can not be used as a measure.

So if we know that :
The profit factor is the ratio when we divide profit from winning trades by the loss of losers.
The Win rate is the percentage of winning trades based on the number of total trades.
The payoff ratio is the average winning trade divided by the average losing trade.

There is a rule about the Profit factor and payoff ratio :

The profit factor will stay constant if we lower the payoff ratio only if we develop a higher win rate strategy.

Payoff ratio calculator

 

How to count profit in forex?

In forex, the best way to calculate profit is to use percentages. In that way, you can measure daily, monthly, or yearly percentage gain. For example, the best trading performance is a 20% annual profit gain.

 

One important thing that we need to separate is one of the most common questions in finance.
Is the payout ratio the same as the payoff ratio? The payout ratio shows the proportion of earnings paid out as dividends to shareholders. The payoff ratio is the portfolio’s average profit per trade divided by the average loss per trade.

Conclusion

All in all, having a good understanding of pay-off ratios is essential for any investor looking to maximize returns from their portfolio. By giving insights into trade performance and potential areas for improvement, it helps ensure that decisions are made with full knowledge of up-to-date market conditions and allows traders to react quickly when changes occur – ultimately helping them stay ahead of the curve and maximize profits in any given situation.

What is Maximum Drawdown?

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A common occurrence in trading is a drawdown that can blow a trader’s account balance. To minimize the effects of a drawdown, traders should set stop losses at important price levels and have a solid money management plan.

But let us start from main definition:

What is the drawdown in trading?

In trading, drawdown represents a percentage of how much your trading account balance is down from the peak before it recovers back to the peak. However, traders recognize three types of drawdown: Maximum, Absolute, and Relative.

We wrote more about absolute drawdown in our previous article.

What is the maximum drawdown?

The maximum drawdown represents the price difference between the maximum portfolio value (peak) and the most significant decline  (minimal portfolio price level) during some trading periods. For example, if the deposit amount for your trading account balance is $10000, the maximum portfolio value, for example, was $16000, and the minimum was $7000, then the maximum drawdown is $16000-$7000=$9000.

Maximum drawdown formula is:

Maximal drawdown = Maximum distance (Maximal Peak – next Minimal Peak)

Please see the maximum drawdown example on  the chart:

maximum drawdown vs absolute drawdown

So explaining maximum drawdown is very easy.

Practically, you have a trading account with a balance of $10000. In one moment, you make maximum profit and reach, for example, $16000. Now, if you, in one moment, have a minimum balance of $7000, we can say that the maximum drawdown is the difference between your portfolio maximum ($16000) and portfolio minimum ($7000).

Please watch my video about maximum drawdown:

 

Conclusion

A drawdown is a normal moment in trading because each trader has ups and downs. However, drawdowns need to be as low as possible because big fluctuations can lead to losing money in trading. For example, I am trying to keep my maximum drawdown below 10 percent. When I manage money for big corporations, I need to maintain a drawdown of less than 5%.

 

What is Absolute Drawdown? – Maximal Drawdown vs Relative Drawdown vs. Absolute Drawdown!

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In any investment, it is essential to be aware of the risks that come with it. One such risk is known as a drawdown. A drawdown measures any performance and how much it can absorb a loss before it goes into profits. It is related to a single position where you enter, and the price may go against you and put you in a relative loss before going up again.

It is also measured on a whole portfolio, where you take the winners and the losers together to determine the highest sequence of accumulating losses in the portfolio. Knowing these risks can help you make more informed decisions about your investments and help protect your money.

What is the drawdown in trading?

In trading, drawdown represents a percentage of how much your trading account balance is down from the peak before it recovers back to the peak. However, traders recognize three types of drawdown: Maximum, Absolute, and Relative.

So, you need to imagine drawdown as the difference between the high point in the balance of your trading account and the subsequent low point of your account’s balance. Usually, we see drawdown as something wrong because it reflects lost capital due to losing trades.

What is Absolute Drawdown?

The absolute drawdown represents the difference between the initial deposit and the minimal point below the deposit level. For example, if the deposit amount is $10000, the maximum portfolio value is $16000, and the minimum is $7000, the absolute drawdown is $10000-$7000=$3000.

Absolute drawdown measures the amount of initial risk involved in the investment. The absolute drawdown shows how big the loss is compared to the initial deposit during the trading. If the absolute drawdown value is 0, no capital is at risk.

Formula: Absolute Drawdown = Initial Deposit – Minimal Equity

Absolute drawdown forex example

absolute drawdown

Please watch the video that I created on my youtube channel about absolute drawdown:

As we can see, the distance from $10 000 to $7000 is $ 3000, and it is the distance from the initial balance to a value below the initial balance.

What is the maximum drawdown?

The maximum drawdown represents the difference between the maximum value (peak) and the most significant decline  (minimal portfolio level) during some trading periods. For example, if the deposit amount is $10000, the maximum portfolio value is $16000, and the minimum is $7000, then the maximum drawdown is $16000-$7000=$9000.

The drawdown and equity monitor indicator is presented below:

drawdown indicator equity monitoring

Download the drawdown indicator below:

DOWNLOAD DRAWDOWN INDICATOR

 

Absolute drawdown vs. maximum drawdown vs. relative drawdown

In its most basic sense, drawdown refers to the relative risk involved with a particular securities investment.
When faced with any investment decision, it would be wise for investors to consult as many and as several various indices as possible before making that purchase or sell. One of the most critical indicators is the general capital trend associated with security.

This article 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 particular 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 your initial investment value. 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.
Understanding that a drawdown is essential when choosing a PAMM provider or a Zulutrade signal provider is necessary.

Absolute drawdown vs. maximum drawdown

In your chart, the maximum drawdown refers to the difference between a local max and the following minimum. This spread can show you the potential profit value locked in the trading pair you have selected. If the maximum drawdown is higher than the currency pair’s profit potential, it might not be an investment you want to consider. One of the most central strategies traders use to guide them in 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)

absolute drawdown vs. maximum drawdown

So we need to find the highest high till lowest low in trading balance $16000 – $7000 = $ 9000.

What is relative drawdown?

The relative drawdown is the maximal drawdown percentage that shows the ratio between the maximal drawdown and the respective local upper extremum (of equity) value.

Relative Drawdown = MaxDrawDown % = Max Drawdown / its MaxPeak * 100%

Absolute drawdown vs. Relative drawdown

While relative drawdown is the maximal drawdown percentage, absolute drawdown represents the difference between the initial deposit and the minimal point below the deposit level.

absolute drawdown vs relative drawdown

What is a suitable drawdown in forex?

The suitable drawdown in forex is less than 5% maximum drawdown based on major prop trading companies’ trading rules. However, retail traders imply that a maximum drawdown of less than 20% is optimum for a trading account. Usually, retail traders risk more money, and their perception differs from professional traders who manage significant funds.

Conclusion

Forex trading often relies upon keen intuition and interpretation for charts and data 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.

The most important thing is to measure Maximum Equity Drawdown because this is the most important criterion for measuring a good portfolio. If we look only at balance, many traders who do not stop-loss or use broad stop-loss will avoid showing absolute equity drawdown, bringing huge problems to investors’ or traders’ minds. The worst thing is when the trader thinks he has an excellent strategy and strategy because of the vast equity drawdown.

Absolute drawdown is an excellent measure of our performance in the first months of trading and comparing it with the initial balance. Still, maximum and relative drawdown are much better solutions for long-term portfolio analysis.

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