Drawdowns and Money Management

No matter how good your Forex trading strategy is, you will lose some of your positions. There is no such thing as a 100% sure win in trading, so eventually you will encounter some loss. This is where the money management kicks in and helps you to limit your drawdowns in order to save your trading account from the complete wipe-out.

The problem with the drawdowns is that if you lose 10% of your account, you need to recover 11% of what remains to return to the breakeven point. Losing 20% will require 25% gain over the remaining balance to recover. As you see, if you trade with the percentage risks, recovering from losses is much harder the more you lose. Trading with a small risk ratio is a good way to prevent such problem from occurring. If you trade long enough, you will encounter streaks of losing trades — for example, with 10 losing positions in a row and 10% risk ratio you will lose more than 60% of your initial balance. But if you trade risking only 3% of your current balance you will end up with 26.3% total loss. You do not need to be a genius to see that it is a lot easier to recover from a 26% loss than from a 60% one.

Of course, trading with just small parts of your account does not look very promising because you decrease your potential profit. But believe me, if you somehow lose 70% of your account — and that is not a hard thing to do if you risk a large part of your capital with each trade — you will have to more than double your remaining funds to reach the breakeven point. Remember, that all professional Forex traders (and even professional poker players) always risk only a small fraction of their capital with each trade they take.