Having the correct risk management will allow you to take advantage of the multiple market opportunities that happen every day. So what we're saying is--make sure you take the proper steps so you do not allow your balance to reach or exceed the maximum allowable established limit.
This limit will be recalculated as your account balance increases and reaches new highs and is also evaluated throughout the day- Taking into consideration Realized and Unrealized PnL- not only at the end of the day. The drawdown will increase as the balance increases (a trailing drawdown) until it reaches the daily starting balance. This will be the case during both the evaluation and during your time with your funded account.
To understand this rule, we will give a graphic and detailed description of how the drawdown works.
$50K Program with a Maximum Allowable Reduction of $2,000
When the evaluation starts, your initial balance is $50,000 and the drawdown is $2,000. So this means, at this point in time, you cannot allow your account balance to drop to $48,000. As your account balance increases, this maximum allowable drawdown will remain in the same proportion until you reach the initial balance.
So, if the first day earns $500- Taking into consideration Realized and Unrealized PnL- , the account balance is now $50,500 and the drawdown is now at $48,500. Why? We calculate this by taking the initial $50,500, subtract the drawdown of $2,000 and now the limit has become $48,500.
Let's say that on the second day, you make a profit of $1,500 increasing your balance to $52,000. This means that and drawdown now can not dip below $50,000. Why is this? Well, we took the current balance of $52,000, subtracted the maximum drawdown of $2,000 which now establishes your limit at $50,000.
This continues until your trailing drawdown reaches the starting balance of your account, or in this case $50,000, at which point the drawdown will no longer trail above $50,000.
So, on the third day, you earn $300. This means your balance is sitting at $52,300 and the drawdown is now at ... $50,000--Why? When the drawdown reaches the initial balance (for this example $50,000) it will remain fixed.
Now, on the fourth day, you have a loss of -$400 and your account balance is now $51,900 and the drawdown is now at ... $50,000--Why? Remember that when you reach the initial balance you will be fixed there.
Next, let's make a visual representation of how this works:
Now, let's look at another example where your balance drops after series of negative trading days:
The initial balance is at $50,000 and the drawdown at $48,000. The first day has a loss of -$500, so the balance is now at $49,500 but there is still wiggle room because the drawdown remains at $48,000.
The next day you have a loss of -$500, which brings the balance down to $49,000, but the drawdown will remain the same because it is still at $48,000.
Following that, you have a series of positive days, which brings the balance of your account up to $51,000.
This means that NOW the drawdown ALSO moves up and is now settled at $49,000.