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The maximum drawdown is equal to the highest drawdown value over a given period of time. In a trading system, it refers to the largest drop (could be expressed as a percentage) of your portfolio.
This technical analysis indicator can be applied to any price series or indicator. It performs the maximum drawdown calculation over a specific number of past bars and using a long or short logic.
The drawdown calculation is different depending on the long/short logic. This means that you can apply this maximum drawdown indicator with the long/normal logic if you want to get the largest drop in a time-series from its highest value and use the short logic if you are looking for the largest increase from its lowest value (Same as when shorting stocks).
The maximum drawdown is a very important metric when analyzing the performance of a trading system. Traders always try to develop and create new money management rules and strategies in order to reduce the maximum drawdown of their portfolio.
I often use and include this indicator in my trend following strategies. The function allows me to search for stocks with a steady increase or decrease in price. To do this, I use the following trading rule:
MaxDrawdown(close, 50, 1) > -2
This trading rule calculates the maximum drawdown of the close price over the previous 50 bars and then returns a signal if the maximum drawdown is higher than 2% (lower than -2). It also means: Give me stocks that never decreased more than 2% from their peak in the last 50 trading bars.
Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.
