Copy trading is now one of the main means for new investors and the ones that do not have time for the markets to be automatically done during the copying of expert traders. Still, the understanding of drawdowns is vital for the whole process of copy trading, as they are the main indicators of risk and the safety of the account.
A drawdown in copy trading is the decrease that a trading account goes through during the cycle from the highest value (peak) to the lowest value (trough) and then again to the attainment of a new high. In other words, it indicates the maximum drop of your account during the losing periods.
It is generally accepted that drawdowns are an integral part of trading. Even the most successful traders suffer drawdowns at times due to the changing nature of the market.
Drawdown Formula
Typically, drawdowns are computed in terms of percentage:
Drawdown (%) = [(Peak Value - Trough Value) / Peak Value] x 100
To illustrate, if your account reaches $10,000 and then decreases to $9,000, the drawdown will be 10%.
Many beginners confuse drawdown with loss, but both are different:
An account may be considered profitable in the long run, but still it can have occasional drawdowns. Consequently, the understanding of drawdowns is necessary whenever using any copy trading software.
Why Drawdown Matters in Copy Trading
1. Indicates Trader's Risk Level
When selecting a trader on a copy trading platform, drawdown helps you understand their risk appetite.
2. Maximum Drawdown (MDD)
Maximum Drawdown (MDD) is the peak-to-trough observed decline to which the trader was subjected. It indicates the worst case that you might encounter while copying that trader.
The trader who imposes a limited MDD is usually the one to develop your account balance consistently through time.
3. Drawdown Makes Recovery Process Harder
It is ratio between drawdown and the ability to recover which is inversely proportional:
For this reason among others, professional copy traders are very much risk management focused rather than high returns only.
4. Psychological Effects
Big drawdowns can lead to traders suffering from stress and panic followed by making wrong decisions such as stopping trades at inappropriate times. However, good trading software such as Combiz can facilitate limits that help users avoid emotional trading.
1. Diversify Your Copy Trading Portfolio
No need to depend on one single trader. Allocate your funds to several different traders with various strategies in order to minimize the risk.
2. Drawdown Limits Set-Up to the Maximum
The majority of the advanced copy trading platforms will let you set:
3. Stay Away from Over-Leverage
Using very high leverage will yield greater output but at the same time will also entail greater drawdowns. The selection of traders should be made on the basis of their use of leverage in a prudent manner and one's own risk tolerance.
4. Performance to be Monitored Regularly
Automation does not mean that you should not observe the traders whom you are copying. In case their drawdown rises higher than the comfort level, lower the allocation or stop copying.
5. Look at Investor's Past Activity
It's always a good idea to go with those traders who have a long-standing verified history and who can control their drawdowns consistently rather than going for short term, high profit traders.
Copying the moves of a trader is not an approach that needs to be constantly active and within the reach of a high-return-yielding trader. Rather, it is the slow growth accompanied by controlled drawdowns that counts. Using platforms like Combiz copy trading that emphasize transparency and performance metrics along with risk management tools will assist users in taking better trading decisions.
Understanding drawdowns allows you to:
In copy trading, drawdowns cannot be totally prevented, yet the large uncontrolled ones can. If the right copy trading platform is used, alongside diversifying investing and setting appropriate risk limits, then one can trade with the utmost confidence and safety.
Mastering drawdowns is a necessary condition for achieving long-term success in copy trading no matter if you are a novice or an expert investor.