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Drawdown in Forex Trading

Drawdown is a very important property of any Forex trading report, strategy, or expert advisor. Drawdown characterizes the risk of the employed strategy. Profitability of a given strategy should always be considered in combination with the drawdown because otherwise you will not take the risk into account, and that is a very bad thing to do. Forex is a probability-based activity and thus should be treated from the risk/reward perspective.

Drawdown is a difference between some local maximum point on your balance chart and the next following minimum point in that chart. It is the risk amount by which your strategy can go down during a streak of losses. There are two types of drawdown that are used as important properties of expert advisors (for instance, in MetaTrader platform) — absolute drawdown and maximal drawdown.

Absolute drawdown is the difference between the initial deposit and the minimal point below the deposit level during the whole testing period. It tells you how big your loss can become compared to the initial deposit during the trading. If this value was 0 during the test, then your deposit was not at risk according to this metric.

Maximal drawdown is the maximal difference between the local maximum extremum and the next local minimum extremum in your equity chart. It tells you how low your strategy can go after getting some profit. It can also be called a depth of a losing streak. Generally it is a good idea not to trade with expert advisors that have maximal drawdown higher than profit. But I do not recommend trading even with strategies or expert advisors that have maximal drawdown at levels higher than 25% of the net profit. Mind your own risk-to-reward ratio and do not trade with EAs that do not comply with it.

Now you know what drawdown is and how it is calculated in Forex trading. Unfortunately, in the old versions of MetaTrader 4, the strategy tester incorrectly calculates drawdowns, so if you are testing your EAs, it is better to calculate both the absolute drawdown and the maximum drawdown manually.

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