Maximum drawdown refers to a significant trading measure of a maximum equity loss you’ve incurred in your portfolio. It’s a statistic that can be determined in backtesting and live trading. During backtesting, maximum drawdown reflects the downside risk of your trading strategy while in live trading it helps you identify instances when your strategy might be malfunctioning.
The value of a maximum drawdown (MDD) is expressed in percent and reflects the highest equity loss between peaks. To determine the MDD, you need to calculate your running percent profit and total loss and then utilize the Excel MIN function to find out the maximum drawdown, which refers to the lowest number.
How to Calculate Maximum Drawdown (MDD)?
Below, you can see a step by step guide on how you can calculate MDD in Excel. You can also use other similar softwares such as Google Sheets or Mac Numbers.
Import your trades into Microsoft Excel. In this example, Forex Tester was used to examine backtesting results.
Navigate to File > Import and import your file into Excel.
Then, make a new column and enter the profit from each trade to the running balance. You can see the formula in the image below.
After that, create a percent profit or loss for every trade in the following column. Given that MDD is calculated in percent, you need to find out the percent change for every trade.
Enter the percent profit/loss in the following column to calculate a running total.
After you’ve created a running total in percent, use Excel’s MIN function to identify the lowest number in the column to calculate the maximum drawdown.
As you can see, the formula used in this example is: =MIN(t3:t17)
Simple as that!
Regardless of whether you have a new peak in your account balance, if your current drawdown is larger compared to earlier drawdowns, that’s your MDD.
How do You Find Max Drawdown of a Portfolio?
The same process can be used to calculate the MDD for your portfolio by entering each of your portfolio trades in the spreadsheet.
It is recommended that you calculate your maximum drawdown in backtesting. This will provide you with data that will help you understand what you can expect in live trading. Even though your backtesting outcome created strong returns, if you can’t bear the MDD, you should change your Forex trading strategy.
Calculating the max drawdown in beta testing is also helpful as it will help you see if your backtesting results will be the same in live trading.
Once you finally calculate your MDD in live trading, you will find out how well you are actually doing in real market conditions in comparison to your testing results. In case your MDD in live trading is higher than MDD in backtesting or beta testing, it could be due to changed market conditions, placing reckless trades or if you’ve been trading without following your strategy.
In conclusion, calculating your maximum drawdown in live trading is crucial. It is also highly recommended to do this in backtesting and beta testing as it will improve your chances for success in real market conditions. It’s a really straightforward process so take a brief moment to find out your MDD.
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