Daily drawdown is a crucial risk management mechanism used in trading to limit the maximum loss a trader can incur in a single trading day.
Definition: Daily drawdown is the maximum allowable loss within a trading day, calculated as a percentage of the account's balance or equity at a specific reset time, typically 00:00 GMT.
How It Works:
1.Reference Point: The reference point for calculating the daily drawdown is the account balance or equity at 00:00 GMT. This value resets daily.
2. Calculating the Drawdown: The daily drawdown limit is calculated as a percentage of the account balance or equity at the reset time (00:00 GMT). For example, if the daily drawdown limit is 5%, and the account balance or equity at 00:00 GMT is $100,000, then the maximum allowable loss for that day is $5,000.
Example Scenarios
Direct Losses:
Starting Balance/equity at 00:00 GMT: $100,000 Daily Drawdown Limit: 5% of $100,000 = $5,000
If the account balance decreases by $5,000 during the day (to $95,000), the trader hits the daily drawdown limit, and trading is stopped to prevent further losses.
Profit Followed by Losses:
Starting Balance/equity at 00:00 GMT: $120,000 Daily Drawdown Limit: 5% of $120,000 = $6,000
During the day, the account balance/equity rises to $120,000. At 00:00 GMT our balance/equity are $120.000 Later, due to losses, the balance/equity drops to $114,000. The loss from the peak balance/equity ($120,000 to $114,000) is $6,000, which matches the daily drawdown limit. Thus, trading stops because the trader reached the maximum allowable loss.
Loss Followed by more Losses:
Starting balance or equity at 00:00 GMT is $90,000: Daily Drawdown Limit: 5% of $90,000 = $4,500
During the day, the account balance/equity falls to $90,000. At 00:00 GMT our balance/equity are $$90,000 If the balance or equity drops by $4,500 (to $85,500), trading is stopped.
Key Points to Remember
Reset Time: The reference point resets daily at 00:00 GMT, establishing a new balance or equity for the next day's drawdown calculation.
Percentage-Based: The daily drawdown limit is a percentage of the balance or equity at the reset time, ensuring proportional risk management regardless of account size.
Protection Mechanism: This system protects both the trader and the funding firm from excessive daily losses, promoting disciplined trading practices.
Balance: The total value of the account excluding any open trades.
Equity: The total value of the account including unrealized profits or losses from open trades.
By adhering to these principles, traders can better manage their risk and maintain compliance with the trading firm's conditions.
Yes. Nice one.