The capital drawdown strategy was originally designed to specifically counter a central problem when trading binary options. This is that one of the most demoralizing experiences that you can endure is dealing with a sequence of consecutive losses. Oddly enough, statistics disclose that many novices enjoy some success during their early trading days. Sadly, the excitement of generating such profits produces a false sense of security leading to most of them subsequently suffering serious losses.
Once this demoralizing trend sets in, many beginners start racking up a sequence of losses that they have great difficulty correcting. The main reason that this occurs is that traders tend to become greedy after enjoying a positive run and start to overtrade by risking more than their equity can safely support. They also have a leaning to treat their profits in a more cavalier way than they do their own deposited funds.
In addition, many novices try to combat losses by adopting the practice of increasing the position sizes of each subsequent new trade. However, unless you have addressed and corrected the central reason for your failures, then all this action will do will be to accelerate your losses by larger amounts. This is a sure route to bankrupting your entire account balance quickly.
(Risk warning: Your capital can be at risk)
Dangers of equity drawdowns
If you were to experience or have experienced this depressing sequence of affairs, then you must realize that your hidden and most dangerous foe is equity drawdown. This deadly parameter generates a negative compounding factor that impacts your ability to even just break even. The following table illustrates the dangers of account drawdowns by considering the impact of a consecutive number of 10% losses on original equity of $20,000.
|Account balance:||% Total loss:||% Profit need to recoup original equity:|
If you study the above table then you will deduce that the impact of drawdowns is a compounding effect that can destroy an account very quickly. You will also notice that you will have to achieve profits that increase exponentially following each new loss in order to just break even. As the value of your account plunges, you will discover that recovery will become more difficult, if not impossible, should you persist in using the same strategy.
If you want to correct this situation, then you will need to take dramatic action. For instance, you must immediately stop applying your present trading methods. You must realize that you will have to apply patience and achieve a long sequence of consecutive small wins to emerge out of this mess. A capital drawdown strategy is one method you can deploy to counter these problems.
In contrast, many traders attempt to trade their way out of this difficult situation by opening new positions utilizing higher levels of risk. However, by doing so they are merely risking more on trading strategies that have already been proven flawed. This is just another form of gambling and is prone to long-term disaster.
Another erroneous solution is to inject new capital into your account. However, the wisdom of such an approach is very questionable because you would still not have found an answer to the central problem which is your inability to trade binary options successfully over the long haul. Consequently, if you tried this solution, you would really just be placing additional amounts of your own funds at serious risk.
Most experts recommend that you correct this problem by going back to the drawing board and designing a capital drawdown strategy. By doing so, you will then throw any thoughts of swift profits out of the window and commence a new approach that involves increasing your risk level per trade in small incremental steps. Your new strategy will be aimed at helping you develop your skills and controlling your losses so that you can gradually recoup your original positions.
Why use a capital drawdown strategy
The prime purpose of your capital drawdown strategy will be to counter the insidious problems listed above. Your first simple step in designing such a suitable binary options strategy will be to follow expert recommendations by limiting your risk exposure to a maximum of 2% of your account balance per trade.
The reason why this percentage is advised is that you will still have about 82% of your account intact if you endured 10 successive losses. In contrast, your balance would be dramatically reduced to just 34% of its original amount if you risked 10% per trade under the same conditions. Consequently, a Capital Drawdown strategy based on such concepts will eliminate the need for you constantly replenish your account balance.
Your strategy should also advise that if you do have to inject new funds into your account in order to stave off margin calls, then they must be minimum amounts. The main objective of your new tool will be to produce evidence that you can really attain consistent profits by implementing small well-controlled steps over an extensive period of time.
In addition, your strategy must encourage you to develop your trading psychology so that you are not intimidated by the sight of a falling account balance. Once you have mastered the art of achieving one small profit at a time, you will find that not only will you recover your position but that you can continue to build your equity by proficiently using your new capital drawdown strategy.