When it comes to day trading, understanding drawdown is crucial to long-term success. Whether you’re trading for yourself or aiming to pass a prop firm evaluation, knowing the specifics of "daily drawdown" helps you navigate the rules and manage your risk effectively.
In this guide, we'll cover the key concepts surrounding daily drawdown and answer frequently asked questions to improve your understanding.
What is a Daily Drawdown?
A daily drawdown refers to the largest peak-to-trough decline in the value of a trading account during a single trading day. It measures how much your account value has decreased from its highest point to its lowest point within that day.
Why It Matters
It indicates the level of risk exposure within a single day.
Many proprietary (prop) trading firms have strict rules regarding daily drawdown to protect their capital.
Types of Daily Drawdowns
1. Intraday Daily Drawdown:
Definition: Intraday daily drawdown is the measure of the largest peak-to-trough decline in the value of a trading account within a single trading day.
Timeframe: It considers price movements and account value changes that occur during the regular trading hours of a single day.
Purpose: Intraday drawdown helps traders and prop firms understand the extent of losses that occurred within the day and assess the risk and volatility of their positions on a more granular level.
2. End-of-Day Daily Drawdown:
Definition: End-of-day daily drawdown is the measure of the largest peak-to-trough decline in the value of a trading account or financial instrument at the close of the trading day compared to its highest point during that day.
Timeframe: It considers price movements and account value changes over the entire trading day but focuses on the closing values.
Purpose: End-of-day drawdown provides a snapshot of the maximum loss experienced throughout the trading day, giving traders and prop firms an idea of the overall risk and performance over the entire day.
Prop Firm Without Daily Drawdown
Many traders search for a prop firm that doesn’t impose daily drawdown rules to provide more flexibility in their trading. While some firms may offer more lenient rules, most reputable prop firms still include daily drawdown limits to prevent excessive risk-taking.
Things to Look For in Prop Firms:
Daily vs. overall account drawdown limits.
Rules for trailing vs. static drawdown.
End-of-day vs. intraday evaluations.
What Does 5% Daily Drawdown Mean?
A 5% daily drawdown means that your trading account cannot lose more than 5% of its total value in a single day. If you breach this threshold, your account may be terminated or flagged, depending on the rules of your prop firm or broker.
Example:
Account balance: $50,000
5% daily drawdown limit: $2,500
If your account balance drops to $47,500 during the day, you’ve reached the maximum allowable loss for that day.
How Do You Calculate Daily Drawdown?
To calculate your daily drawdown, follow these steps:
Identify the highest account value (peak) during the day.
Determine the lowest account value (trough) during the same day.
Subtract the trough value from the peak value.
Formula:
Daily Drawdown = Peak Value - Trough Value
Example:
Peak account value: $52,000
Trough account value: $48,000
Daily Drawdown = $52,000 - $48,000 = $4,000
In this example, the daily drawdown is $4,000.
What Is an Example of a Drawdown?
Let’s explore two types of daily drawdown examples to illustrate the concept:
Intraday Daily Drawdown Example:
Starting balance: $50,000
Highest point during the day: $52,000
Lowest point during the day: $48,000
Intraday Daily Drawdown = $52,000 - $48,000 = $4,000
End-of-Day Daily Drawdown Example:
Opening balance: $50,000
Closing balance: $49,500
End-of-Day Daily Drawdown = $50,000 - $49,500 = $500
Does Daily Drawdown Reset?
Yes, daily drawdown typically resets at the start of the next trading day. Once the new trading session begins, your drawdown calculation starts fresh, based on the new day's trading performance.
Key Considerations:
Some prop firms reset daily drawdown limits at market close.
Others may apply specific reset times based on time zones or trading hours.
Is Drawdown Good or Bad?
Drawdown itself is not inherently good or bad—it’s a natural part of trading. However, excessive or poorly managed drawdown can lead to:
Capital loss: Draining your account balance.
Psychological stress: Impacting your confidence and decision-making.
Healthy Drawdown Practices:
Stick to your risk management plan.
Avoid revenge trading to recover losses.
What Is the Maximum Drawdown Days?
Maximum drawdown days refer to the longest period over which your trading account stays below its peak value without recovering.
Why This Metric Matters:
It shows how long it took for your account to bounce back after a significant loss.
Helps you evaluate whether your trading strategy can handle prolonged drawdown periods.
How Do You Avoid Drawdown in Trading?
Avoiding large drawdowns is essential for staying in the game as a trader. Here are some practical tips:
Set Daily Stop-Loss Limits:
Use risk management tools to cap your losses for the day.
Avoid Overleveraging:
Trade within your account size and avoid excessive margin use.
Stick to Your Trading Plan:
Avoid deviating from your strategy due to emotions.
Diversify Trades:
Don’t put all your capital into one trade.
In Summary
The intraday daily drawdown focuses on the fluctuations within the trading day, while the end-of-day daily drawdown considers the overall performance from the market open to close. Both measures provide insights into the volatility and potential losses during different time frames.
