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Crypto prop trading comes with a set of strict rules that a trader must follow in order to be accepted as a trader. It is critical to understand the workings of crypto prop trading, as many traders attempt hundreds of evaluation/challenge rounds but never qualify.
Traders are given a funded trading account to start the trading process. Every trade must be processed according to a set of rules. This adds extra weight to a trader’s shoulders. With every minor swing in market prices, traders lose weeks of profits, which can lead to the termination of their prop account.
We have deciphered the mantra for smoothly operating your prop account and even qualifying for the evaluation process in one go. The mantra is to understand the downdraw rule. Let us first define the role of drawdown in prop trading.
As the name implies, in a drawdown, when the trades are on a losing streak (down), the firm has predetermined a stop sign where the trader must draw out. The central idea for a drawdown is to draw a loss limit for the traders. As the amount of a prop firm is pooled, and the firm is answerable for the losses, this drawdown limit is taken seriously by all.
Downdraw refers to the amount returned to the firm while the trades were losing flow. Prop firms view it as a risk management strategy to protect instant funded accounts. There are different types of drawdown with aligned rules. We will break them further down with illustrations.
The prop trading firms mainly use two rules that’s daily drawdown and overall drawdown but there are several others. Let us understand them
1. Daily Drawdown:
It defines the maximum loss a prop firm can suffer in a day.
2.Overall Drawdown:
It defines the overall or lifetime drawdown limit of a funded account. FTMO charges 10% as the overall drawdown. Let’s understand with the help of an example. If the overall funded amount is $100,000, the total loss limit should be $10,000.
Further, there are other downdraw limits as well. Let’s learn about them.
3.Static Drawdown limit
The limit is predetermined by the prop firms and is used to keep the funded amount secured for extra losses. The percentage of static drawdown is revealed after the evaluation process, ensuring complete transparency.
4.Trailing Drawdown limit
Trailing drawdown limit changes with high earnings. As the trader earns more profit, the drawdown caps are pushed to save the new profits from future uncertainties.
5.Dynamic Drawdown limit
In dynamic drawdown, unlike static, the cap moves as per the market movement. With crypto, rallies and plunges in the cryptocurrencies are more frequent. There are other factors also involved to ascertain the limit, such as the trader’s profit, risk management, and adaptability.
6.Equity-based drawdown
This includes two types of profit and loss, realized and unrealized, while accessing the limit.
7.Balance-based drawdown
According to your balance, if you have successfully recovered from the balance closing or allowed equity to fall, the maximum drawdown limit. This drawdown is popular among swing traders.
The purpose of drawdown is much deeper than anticipated. Companies use it as a safety net against higher losses. For traders, it is a disciplinary action that limits their ability to play on emotions. For investors, it serves as a trust-building factor.
It also aids in assessing traders’ psychological approach and seriousness about following the rules, risk management ability, and understanding of cutting losses.
Overall, drawdown identifies these factors.
Traders make some common goof-ups with drawdown that result in adverse consequences. Here are they:
If you are someone who ignores warning signs and loses their prop account, here is a checklist for you.
For professional traders, understanding is crucial, yet complex. The drawdown concept is not only for prop firms but can be adopted for all traders. It is a straightforward, simple concept that helps in saving from catastrophic losses. In this article, we tried to simplify the concept with the help of examples.
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