Trailing Max Drawdown

Key Highlights

The trailing maximum drawdown is often calculated based on the peak balance that your trading account has ever recorded. Below are its key features:

• Some prop firms use trailing maximum drawdown rules during the evaluation stage, while others apply them only to funded accounts. The exact model depends on the firm’s risk policy.
• A trailing maximum drawdown setting that has been set at the $0 mark will lead to position liquidation, including the cancellation and closure of all open positions. 
• If the above setting happens by mistake, it’s recommended that you either disable it immediately or adjust it in such a way that the resulting value will be greater than zero. 
• Using customized risk settings when trading will in no way override the margin rules put in place by the prop trading firm. 

Trailing Max Drawdown

A trailing maximum drawdown refers to a risk management tool used by prop trading firms to set a dynamic loss limit for the account. It defines the maximum loss allowed from the highest equity level your account has reached, and is inclusive of trading fees and commissions. 

However, you should note that this trailing maximum drawdown limit will continue to “trail” upwards as the trading balance increases. The adjustment occurring in the account is a way of locking in your profits by raising the threshold every time a trade earns a profit.

The good news is that this trailing drawdown will stop increasing as soon as the account balance has risen to equal the opening balance. By doing this, the trailing maximum drawdown limit will help prevent any further drawdown once your trading account has attained a predetermined profitability level. 

Read on to learn how this type of drawdown works, and get to see examples of it in action!

Trailing Maximum Drawdown Rules 

I think it’s important that we first look at the significance of trailing maximum drawdown to a prop firm before we can look at the various rules in use.

Over my trading career, I have come to see the trailing maximum drawdown (TMD) rule as an essential, but often misunderstood and overlooked, dynamic risk management system.

The prop firms that I have worked with in the past have all used it for one purpose: to keep track of and cap the maximum loss that a trader can make based on the peak equity amounts of their accounts.

When compared to the static drawdown, I can say that these two rules are quite different. One will remain fixed while the other will adjust upwards as the account hits new highs.

But even as it adjusts, please note that this only applies to profits. Downward adjustments following a string of consecutive losses are not a thing in trading. 

In my opinion, therefore, prop firms use the trailing maximum drawdown to protect their capital and encourage strict trading discipline. Below are the two key rules you’re likely to meet here!

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End of Day Drawdown

The end-of-day trailing drawdown is normally based on the realized profits only. What this means is that the drawdown limit will adjust upwards based on the realized profits recorded in your trading account at the close of a trading day. 

It’s a trailing limit that provides you with increased flexibility to recover from any punishing swings you may have experienced during intraday trading activities. Here’s an example to help you understand it better:

1. The account balance at the beginning of your trading session is $50,000
2. With this kind of balance, the maximum drawdown will be set at $48,000
3. If you’re able to make a profit of, say $1,000 when trading various assets, but fail to close the open positions, it means the drawdown limit will remain at $48,000.
4. At the end of the trading session, your new account balance will be $51,000. Based on this new balance, the prop trading firm will then adjust your drawdown limit to $49,000.
5. This will be the new drawdown limit when trading resumes on the following day. 

Please note that while the end-of-day trailing drawdown will only be updated at the close of your trading session, prop firms will, in fact, enforce it on a real-time basis. What this means is that if you hit the drawdown limit during the trading session, the account will be seen to have failed. 

Real Time or Intraday Trailing Drawdown

The real-time or intraday trailing drawdown is an elite evaluation plan where the drawdown limit continues to shift in real time during your trading activities, and will take into account all gains made in a session, including the unrealized profits. 

How this works is that every time an open position earns a profit, the account automatically adjusts the drawdown limit to match this new level. The downside to this drawdown is that when an open trade takes on a loss, the updated levels remain, which may, unfortunately, trigger account termination. 

Example:

1. Your funded account balance at the start of trading is $50,000, with the account having a maximum drawdown limit of $48,000.
2. During intraday trading activities, the account manages to make a profit of $1,500, which is immediately noted as an unrealized profit margin. Nevertheless, the drawdown increases up to $49,500.
3. Given the prevailing conditions in the market, you leave the position open, a fact that sees it climb further by $2,500. At the same time, your drawdown limit climbs up to $50,500.
4. At the end of the day’s trading activities, the account gets to close with a total realized profit of $1,000, with the drawdown limit remaining locked at the $50,500 mark. 
5. With the movements that happened during trading, it means that if the account were to drop below $50,500, the prop firm's rules would have been breached, leading to its termination. 

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How a Trailing Maximum Drawdown Can Set You Up for Success

Prop firms that employ the trailing max drawdown rule during the evaluation phase do so to prepare you for challenges that come with running a funded account. Here’s how this rule can set you up for success down the road:

• Realistic Risk Management Practice: Considering that the evaluation phase typically uses a conservative drawdown model, this rule will enable you to develop a solid approach to risk management. 
• Skill Development: The use of a trailing drawdown in an evaluation phase encourages a disciplined trading approach that teaches you to manage risk and lock in your gains. 
• Structured Path to Scalability: Adapting to this type of drawdown will enable you to build a habit of securing your gains as you continue scaling to larger funded accounts. 

Conclusion

The trailing maximum drawdown is a loss limit level where the maximum allowed loss follows the highest account balance recorded during your trading activities. There are two main types of trailing max drawdowns: real-time and end-of-day. The real-time drawdown gets updated on an ongoing basis every time a new high is recorded during the day’s trading activities. An end-of-day limit will only be updated at the close of the session, and will be updated based on the prevailing balance. 

As you begin trading, make sure you’re well-versed with the different points where the lock-in and the hard breach may occur. At Audacity Capital, our team is constantly updating our resources section to ensure you have all the information needed to make an informed decision. And please note that we have different drawdown models in use for the different types of funding programs available. 

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