How to Manage Drawdown When Doing a Prop Firm Challenge

  • October 10, 2022
how to manage drawdown

Forex prop firms typically all have fairly strict maximum drawdown limits and daily loss limits. This leads to traders frequently failing challenges, even if they’re profitable traders when trading their own accounts. These drawdown limits are for good reason, as navigating these limits will prove that you’re ready to trade large sums of capital. Luckily, there are various techniques you can use to reduce the risk of violating these maximum drawdown thresholds. 

In this article, we are going to look at how to approach your prop firm challenge account and a technique you can deploy to (hopefully) increase your chance of passing! Let’s get into it…

Drawdown Management During A Forex Prop Firm Challenge

One of the benefits of trading with an online prop firm is the fact you have to remain accountable. When you’re solely trading your own capital, especially small capital, it’s hard to stay accountable. I know so many retail traders that will happily lose 20% of their personal trading capital and not think twice, just blaming ‘the market’ for the loss. Being held to a higher standard by way of a drawdown limit is a great way to force accountability and ultimately make you a better forex trader. This is just one of the many reasons you should be trading with a prop firmWith that being said, this doesn’t help you get funded, right? If you’re reading this, I’m assuming you’re looking to acquire funded trading accounts and may need a bit of assistance managing the potential losses…

Let’s look at the parameters you’re working to, then how we can approach them…

Working Within The Parameters

The first step in effectively managing losses and drawdowns is to understand how far you’re able to push the envelope. Let’s take our Elite Trading Club traders, for example. When we give capital to our funded forex traders, we set a drawdown limit of 4%. This is lower than most prop firms, but we offer live/real trading capital, rather than demo accounts. Most retail forex traders will lose around 50% of their trades, even with an edge in the markets. If you’re losing half of your trades, it’s very much possible to lose 10, even 20 trades in a row in certain market conditions. If you were to approach the Lux Trading Firm account challenge with a 1% risk per trade, you could easily violate the maximum loss, even if you’re a profitable trader.

Using a risk profile closer to 0.2% per trade would be a much more realistic approach if you were serious about maintaining your account balance and becoming a professional trader.  We’ve often seen many technically profitable traders violate the rules and take heavy losses, even when their equity curve has previously been very positive. If you cannot work within the maximum loss parameters, you will make it very hard to become a funded forex trader! This is why most forex traders fail!

The Pyramid Entry Technique

As a retail forex trader, I learned the majority of my risk management techniques from websites like Babypips. Although great and very useful, the large majority of the techniques shown are very low-level or basic. Due to the focus on these basic techniques, more complex techniques like Pyramid entries are not widely known in the retail community. Pyramid trading, in essence, is adding more position sizing onto winning trades, without increasing your net risk per setup.

An example –

  • You take a Sell on EURUSD at 1.03553 with a 50 pip stop loss and a 400 pip take profit.
  • The risk on the trade is 0.1 lot, meaning you’ll lose £50 if you’re wrong and make £400 if the market hits your full target.
  • Your analysis is right, and the market has fallen 100 pips. The moving averages have crossed, and the market is bearish. We have broken a support level too.
  • At this point, you move your stop loss to breakeven. Although you have committed to losing £50 in this trade, you now have £0 risk on the table.
  • Now, add another short position where suitable. This position has to make sense from a technical point of view, but also have a large stop loss. This entry will not have the best risk-to-reward ratio, perhaps aim for 1:1 or 1:1.5. A large stop loss is crucial. Make sure that the maximum risk on this trade is £50.
  • Repeat this process as many times as possible as the trade is running. It’s important to understand that this does not always work, it very much depends on the trading scenario.

In this example, you would have been able to increase your risk to reward from 1:8 to perhaps 1:10-1:11 without ever adding additional risk to the position. Although you’re taking on more risk during the process, you’re also reducing your previous risk as the market develops. This drastically increases how much money you can make forex trading.

It’s a simple premise, but it does take a lot of practice and market hours to pull this risk management strategy off! This strategy does work particularly well with online prop firms, such as Lux Trading Firm, or if you’re looking to trade forex on a budget. By doing so, you’re able to easily stay within the maximum drawdown limits, whilst increasing your profits in those good trading opportunities!

Focus On Loss, Not Profit

It’s a cliché saying in the online forex space, but it really is crucial to focus on the drawdown, not the potential profits. In the prop firm space, many prop firms will let you retake a challenge if you do not reach a profit target. Once you’re a funded trader, you won’t even have a profit target, you’ll just have a drawdown limit! So, why focus on the negative?

Well, the drawdown will cause you to lose the trading account, whereas not reaching a profit target will not.

You can’t control the market. You cannot control when a huge winning trade will come, or how far a winning trade will go in your favor. But, you can control how much money a trade will cost you! It’s crucial to focus on what is actually controllable – the risk you put on the table. Whether you’re trained to think in terms of monetary value, or you think in terms of percentages, being fully aware of the loss thresholds is very important. Before every trade, I’d recommend you ask yourself ‘What is my maximum loss here’, ‘How much can I afford to lose on the trade’. Once you have an honest answer to these questions, you can decide whether you can actually enter the trade or sit this one out.

This also rings true if you’re looking to grow small forex trading accounts.

In Summary – How To Manage Losses When Trading For A Prop Firm

In conclusion, managing your risk is essential if you’re looking to trade funded trading accounts. It’s entirely possible for even ‘less profitable’ traders to have huge sums of capital under management, by just perfecting the risk management piece.

Utilizing a low level of risk per trade, alongside pyramid entries and understanding the risk limits are all great ways to help aid you in getting funded!

Do you have any interesting risk management techniques? Let us know in the comments!

Are you looking to get funded? Contact Lux Trading Firm now!