We’ve all felt that fear of losing our hard-earned compounded gains from our successful strategy, right? We even had times when we doubted that same strategy! As you might have guessed, today we are going to talk about the drawdown.
Disclaimer: Our content is intended to be used and must be used for informational purposes only. It is very important to do your own research and analysis before making any investment based on your personal circumstances.
What is a drawdown?
Simply put, the drawdown is the period of loss, calculated in percentage, after a peak in value reached with your capital. Let us explain: Imagine that you started investing with $100 following your strategy A and that after a series of mostly winning trades you arrive at $150. Very good results, a 50% increase!
Subsequently, after a series of losses, you find yourself at $125 before it goes back up to finally exceed $150, you have regained your capital level before the series of losses. The difference in percentage between the lowest level reached and your capital level is the drawdown. In the above scenario, the drawdown is 16.6%.
Why is this important to know?
If you want to invest in an investment fund, it is important to know what you are getting into and the maximum drawdown can help you do that. Indeed, most investment funds offer several strategies that correspond to different levels of risk.
As you know, in finance, to expect higher returns, we have to accept higher risks. The drawdown is one of the measures that allow you to evaluate the risk of a given strategy and thus help you in your investment choices.
A useful tool for backtesting!
If you are developing your own strategies, either manually or with the help of an algorithm, the drawdown is also an excellent tool because it allows you to classify your different strategies according to their risk.
Be careful though, this is still a tool and as with everything in trading, past results do not guarantee the future, it just gives you an idea of what you can expect when using a given strategy.
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What is an acceptable level of drawdown?
This question is more personal than it seems! Indeed, it depends totally on your appetite and tolerance for risk. For some, a 10% drawdown will be too much, while for others, 25% is the way to go.
How to reduce it?
If a strategy has been properly optimized, it will be difficult to reduce the expected drawdown further. To reduce your overall drawdown, the solution will be diversification which will allow you to allocate only a portion of your capital on a strategy or bots.
Capital diversification and the SMART Bots
No two investors are alike. Depending on your tolerance for risk and your goals, at 4C-Trading, you provide you with options to meet your needs. With SMART BTC, ETH and LINK Bots, and two strategies (Conservative and Aggressive) to choose from, you have the freedom to choose according to your investment objective. If you are unsure, you could select both Conservative and Aggressive strategies at the same time before narrowing it down to one that suits you.
The suggested capital allocation across the three SMART Bots is: 33% of your capital on each bot. Alternatively, if you are interested in SMART Margin as well, we suggest you diversify your capital as such: 25% across three SMART Bots and remaining 25% on SMART Margin.
This way, if one bot under performs due to market conditions, the other bots could cushion the ride. The crypto market never sleeps and things are constantly changing at the speed of light! Hence, when investing, it is important to take the pragmatic approach when assessing your risk profile.