Preschool>= Lesson Status ?
Kindergarten>= Lesson Status ?
Elementary>= Lesson Status ?
Grade 1 Support and Resistance Levels
Grade 2 Japanese Candlesticks
Grade 3 Fibonacci
Grade 4 Moving Averages
Grade 5 Common Chart Indicators
Middle School>= Lesson Status ?
Grade 7 Important Chart Patterns
Grade 8 Pivot Points
Summer School>= Lesson Status ?
High School>= Lesson Status ?
Grade 9 Trading Divergences
Grade 10 Market Environment
Grade 11 Trading Breakouts and Fakeouts
Grade 12 Fundamental Analysis
Grade 13 Currency Crosses
- What is a Currency Cross Pair?
- Crosses Present More Trading Opportunities
- Cleaner Trends and Ranges
- Taking Advantage of Interest Rate Differential
- Obscure Crosses
- Planning Around News and Fundamentals
- Creating Synthetic Pairs
- Euro and Yen Crosses
- How to Use Crosses to Trade the Majors
- How Cross Currency Pairs Affect Dollar Pairs
- Summary: Currency Crosses
Grade 14 Multiple Time Frame Analysis
Undergraduate>= Lesson Status ?
- Why Keep a Trade Journal?
- Benefits of Keeping a Journal
- What Should You Record in Your Journal?
- Potential Trading Area
- Entry Trigger
- Position Sizing
- Trade Management Rules
- Trade Retrospective
- Trading Journal Statistics
- Reviewing Your Trading Journal
- Difficulties of Keeping a Trade Journal
- Summary: Keeping a Trade Journal
Graduation>= Lesson Status ?
- Which Trading Style is Best for You?
- Which Currencies Should You Trade?
- What is Your Level of Trading Experience?
- Should You Be a Discretionary, Mechanical, or Hybrid Trader?
- What Kind of Mechanical System Suits Your Personality?
- What is Your Attitude Towards Risk?
- What Kind of Stop Suits Your Trading Style?
Drawdown and Maximum Drawdown
So we know that money management will make us money in the long run, but now we'd like to show you the other side of things. What would happen if you didn't use money management rules?
Consider this example:
Let's say you have a $100,000 and you lose $50,000. What percentage of your account have you lost?
The answer is 50%.
This is what traders call a drawdown.
A drawdown is the reduction of one's capital after a series of losing trades. This is normally calculated by getting the difference between a relative peak in equity capital minus a relative trough. Traders normally note this down as a percentage of their trading account.
In trading, we are always looking for an edge. That is the whole reason why traders develop systems. A trading system that is 70% profitable sounds like a very good edge to have. But just because your trading system is 70% profitable, does that mean for every 100 trades you make, you will win 7 out of every 10?
Not necessarily! How do you know which 70 out of those 100 trades will be winners?
The answer is that you don't. You could lose the first 30 trades in a row and win the remaining 70. That would still give you a 70% profitable system, but you have to ask yourself, "Would you still be in the game if you lost 30 trades in a row?"
This is why money management is so important. No matter what system you use, you will eventually have a losing streak. Even professional poker players who make their living through poker go through horrible losing streaks, and yet they still end up profitable.
The reason is that the good poker players practice money management because they know that they will not win every tournament they play. Instead, they only risk a small percentage of their total bankroll so that they can survive those losing streaks.
This is what you must do as a trader. Drawdowns are part of trading. The key to being a successful trader is coming up with trading plan that enables you to withstand these periods of large losses. And part of your trading plan is having risk management rules in place.
Only risk a small percentage of your "trading bankroll" so that you can survive your losing streaks. Remember that if you practice strict money management rules, you will become the casino and in the long run, "you will always win."
In the next section, we will illustrate what happens when you use proper money management and when you don't.
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- What is Risk Management?
- Drawdown and Maximum Drawdown
- Don't Lose Your Shirt
- Reward-to-Risk Ratio
- Summary: Risk Management