Trading is a game of profit and losses, wins and defeats. It is a game of odds where high probability is the key to successful trading. A trader identifies a trade with a high probability of success and trades it using professional skills and prudent risk management. If the trade moves in his favor he stands to gain a big amount and if it goes against him he tends to lose a very small amount.
The novice trader, sadly though, understands the importance of risk management after going through many big losses and depleting his trading account considerably. Before he realizes his mistake, he has lost more than 50% of his trading account if he is lucky. Most though, lose everything and give up trading.
With every wrong trade, the trader depletes his account size by a certain amount and then fervently tries to recover it .This back and forth movement normally follows a pattern. He goes back two notches and moves ahead one notch and thus never really is able to recover his losses. He gets entrapped in this whirlpool and like deadly quick sand, he is pulled into it till the death of his account.
Let us say, that a trader has a trading capital of Rs.1 lac. He suffers of loss of Rs.50, 000/- or 50%. Most would say that he just needs a recovery of 50% to be at par once again but this is not the case. He will need to recover by 100% actually to come to par again. This may be explained as under:
He has lost 50% (50,000/- out of 100,000/- trading capital)
He has to gain 100% (50,000/- out of the remaining 50,000/- trading capital)
Thus, simply put, if a trader has a drawdown of 50%, he will have to make a recovery of 100% to be at par.
Drawdown and recovery are very important aspects of risk management and should always be give deep thought. Planning ones losses in advance can help one to recover from them swiftly or avoid them completely altogether.
Successful trading is more about prudent risk management rather than the accuracy of the trade itself.
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