Friday, July 27, 2012

DrawDown, Earnings and Zulutrade: Less is More?

Definition of 'Drawdown' :

The peak-to-trough decline during a specific period of an investment, fund, currency or commodity. A drawdown is usually quoted as the percentage between the peak and the trough.

If you are going to follow any traders (signal providers ) on Zulutrade you will probably look for their earnings. But sometimes more important factor to look for is their DrawDown.
Because a strange thing can happen. Signal Provider with less earnings can make you more profit that signal provider with more earnings! Why?

This has something to do with earnings, drawdown, risk and bankroll management. Check our example below to learn more.

Let´s assume that one would like to trade with a sound Bankroll Management (BRM) and is willing to risk only 2% of his capital per trade.

Now we have 2 SPs (signal providers). Your starting capital is, let´s say $5000.

Signal provider #1
Annual earnings 5000 pips
DD is 20% (means his last worst trade was loss 1000pips! Some traders do not use a StopLoss to generate more profit)
You risk only 2% of your bank (which is $100) you must expect 1000 pips loss again. Your lot size then should be only 0,01 lot (1 microlot)

Signal provider #2
Annual earnings 500 pips
DD is 10% (worst trade 50 pips)
You risk 2% of your bank ($100) with worst trade of 50 pips you can afford to set your lot size to 0,2 (2 minilots)

SP #1 earned 5,000 pips  and SP #2 earned only 500 pips

Now compare your real earnings:
SP #1 : 5000pips while using 1 micro lot/trade gives you $500
SP #2 : 500pips while using 2 mini lots /trade gives you $1000

So when using a proper BRM, sometimes SP with less pips earned gives you more profit than SP with more pips but bigger DD.

Anybody can decide :)

People tend to make a big mistake. They choose SPs with huge earnings to get rich quick. But when a big Drawdown happens they accounts get wiped out.

My advice is to check DD carefully, set your lot size to a safe size and enjoy steady profits.
If you wish to earn much more you can use a power of compounding .

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