One of the most important metrics that you should know is the maximum Drawdown. This term refers to the maximum amount of money you have lost in a series of consecutive bets over a given period , from the time you started trading to the point of maximum loss.
The Maximum Drawdown is a key concept in risk management and financial planning. Knowing your maximum Drawdown allows you to set limits on your bets and minimize the risk of losing your entire bankroll. For example, if your maximum Drawdown is 20%, then you should not bet more than 20% of your bankroll on a single bet or series of consecutive bets.
It is important to remember that the Maximum Drawdown is not a measure of the profitability of your trades, but a measure of the maximum loss that you can suffer. Therefore, you should not confuse the maximum Drawdown with the return on investment (ROI) or yield. A trader can have a relatively high Maximum Drawdown but still make a solid return in the long term, it all depends on the strategy to be followed.
Why is it important to know about the max. drawdown?
An example of how Max Drawdown is used in risk management is setting a daily, weekly or monthly stop loss. Let’s say your Max Drawdown is 20% and your current bankroll is €1000. If you set a daily stop loss of 5%, then you should not lose more than €50 in a single trading day. If you lose €50 in one day, then you should stop and wait until the next day to trade again. In this way, you limit the risk of losing a significant amount of your bankroll in a single day. It must be remembered that this example is not a standard of how to operate nor do we intend to affirm that it is the correct way to do it, we are only exemplifying an operating scenario.
Another example of how the Maximum Drawdown is used is in the selection of trading strategies. If you have a relatively low Maximum Drawdown, then you may want to focus on more conservative trading strategies that minimize the risk of loss. On the other hand, if you have a higher Maximum Drawdown, then you can afford to be more aggressive in your trades and seek higher investment returns.
How is the Maximum Drawdown calculated?
To calculate the Maximum Drawdown, you first need to track your trades and calculate the highest balance in your account at any given time. From there, you should compare the highest balance to your account balances over time and record the difference between the highest balance and the lowest balance at each point in time. The Maximum Drawdown is calculated as the percentage of the difference between the highest balance and the lowest balance. The mathematical formula to calculate the maximum Drawdown is:
Max Drawdown = (Highest Balance – Lowest Balance) / Highest Balance x 100
For example, if your highest balance is €1,000 and your lowest balance is €500, then the maximum Drawdown would be 50%:
Drawdown máximo = (1000€ – 500€) / 1000 x 100 = 50%
In short, Max Drawdown is a key metric for any sporting event trader. Knowing your maximum Drawdown allows you to set limits on your bets and minimize the risk of losing your entire bankroll. In addition, Maximum Drawdown helps you select the right trading strategies and set daily or weekly stop losses to control risk. If you are serious about being a successful trader in sporting events, you must understand and use the concept of Maximum Drawdown.