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Drawdown or refund rate? Set your priorities
If you have been on the market for some time, you must have read or heard slogans such as "the most important thing is capital management" or "never risk more than 2% of your capital on a transaction". I will not write anything revealing stating that there is a lot of truth in it, a money management and most of all control Drawdown is one of the most important factors. Of course, there are also interesting questions, more behind the scenes "what was your rate of return this year?". Except that then hardly anyone asks at what risk, and this can explain a lot.
Why is it so important? I will try to explain this to you in this article.
Drawdown, or cit is a slide
| Maximal Drawdown (DD) | The maximum subscription of equity, ie the difference in the level of the maximum account reached and its minimum including the balance of open positions (Equity). | Example: Maximum value of 1000 PLN account, maximum total sum of lossy 500 PLN positions. Max. DD is 50%. |
| Absolute Drawdown | The difference between the deposit paid and the minimum recorded value of the account including the balance of open positions (Balance - Equity). | Example: Initial payment of 800 PLN, maximum total loss of 400 PLN. Absolute DD is 50%. |
Typically, when writing "sink", traders understand this as the first term by default.
Risk appetite
Our risk appetite is determined by goals set for oneself, owned capital (not only the one invested in FX) but also our disposition. Going from the end. Some people are not afraid of the risk and jump with a parachute, others try to avoid it at every step and prefer recreational cycling. If we have large capital and invest only a small part of it in the financial markets, we are also generally able to play more aggressively. If the total sum is not too large, we try to respect every penny (although our disposition likes to make a little confusion here sometimes).
READ NECESSARY: Choosing an effective capital management method
How much we risk also results from a specific goal - if we want to achieve at least a 3-digit rate of return, then we either have to be very experienced, or we risk more. Defining an achievable goal in relation to the knowledge and skills we have allows us to work out a certain balance here, which is undoubtedly healthy and reasonable. The only question is how to set a realistic goal when we have no experience?
Set your priorities
Ask yourself one simple question - are you willing to risk X% of your capital to earn Y%? If so, you need to ask yourself a second, more difficult question - what is the chance that you will succeed?
It's worth establishing yours priority - is it the highest possible rate of return or the lowest possible risk? One always affects the other and there is no derogation from it, so before we start trading, we must clearly define what is more important to us and by how much.
Result optimization
One of the economic guiding ideas is that every enterprise (at least in theory) always strives to optimize the economic result, i.e. simplifying it to earn as much as possible with the least possible losses.
On the capital markets, we are dealing with an analogous situation. The best solution is to earn as much as possible, risking as little as possible. So how do you find this balance point? It is the result of the level of risk we accept and the goal that we need to level.
Assuming that from our previous experience it results that in combination with a stable situation on your favorite instrument and maintaining a certain effectiveness, we get an average rate of return at 50% on an annual basis when you deplete 10%. If we initially determined our readiness for a possible loss of 20%, it means that we can optimize our result by increasing the volume of transactions and thus achieve twice the rate of return.
READ ALSO: Confidence in trading - how to develop it?
Of course, this is only a theory and assumes unchangeable conditions and the way we do it, but the above example only has to outline the approach to optimization.
Large capital likes small risks
If we do research among the offers of large hedge funds, we will soon discover that for them the most important factor is not the highest rate of return, and the lowest risk, that is, the dropping of capital. Stability of the obtained results, i.e. the psychological peace of their clients combined with a positive rate of return in the long term almost guarantees a continuous inflow of new capital, and thus an increase in management fees.
Let's also put ourselves in the place of a wealthy investor who owns assets worth 10 million USD. Donating 1 million USD for investments to the manager or such an investor usually thinks that during the year 5 have so many times and at the same time to wonder whether tomorrow will not lose everything or to gain 5% over 100 years and risk a maximum of 10% of the invested amount? Question quite tricky, because it can also be dependent on the previously mentioned disposition and goals. In general, the safer option is more desirable.
Little capital likes ...
One can come to a simple conclusion. If we want to be big investors someday, we should think and act like them - albeit on a smaller scale. It will take (theoretically) more time, but if we do not limit the risk ourselves (to a reasonable and at the same time satisfactory level), the risk is very likely to do it to us as a result of losing a significant part of the capital.
