What is Equity-Based Drawdown and How to Calculate

Equity drawdown is a drop or decline in your equity from its daily peak value. It is a risk management system that empowers one to become a strategic, responsible, and disciplined trader.

Equity is the total value of a trading account. It includes your account balance for the day and any unrealized profits or potential losses on open positions.

It changes depending on the performance of your live trades.

Today, we will look at equity-based drawdown (EDD); how it works (how it is calculated), it’s advantages and how to prevent or manage it (drawdown):

How equity-based drawdown works

Unlike balance-based drawdown that considers money lost or won from closed positions and calculated at the end of each trading, EDD is a real-time metric that fluctuates with price movements. It focuses on both realized and unrealized profits/losses.

It is used by prop firms to ensure traders manage their risk effectively and become efficient.

Here’s how to calculate equity-based drawdown:

1. First, determine your starting day equity — Starting equity is your daily equity balance (which resets around 21:00 UTC everyday).

2. Next, identify the current equity value — Current equity is the overall value of your trading account at the present moment. This figure usually fluctuates throughout the trading day as your positions gain or lose value.

3. Calculate the difference between your daily starting equity and your current equity.

4. Express the result in percentage.

(Equity-Based Drawdown (EDD) = (Daily Starting Equity – Current Equity) / Daily Starting Equity x 100)

Let’s shade more light with a context:

An account of $10k without any live trade(s) has a daily starting equity of $10,000. (Why? It’s because there’s no unrealized profits or losses yet).

But next, (if) you place some trades and have an unrealized potential loss (UPL) from holding the unprofitable position(s) of say -$150, your EQ would decrease to $9850.

And based on the EDD formula, your equity drawdown would now be: 10000 – 9850/10000 x 100 = 1.5%

And if you continue holding the unprofitable position(s) say to -$250, EQ goes down to $9750.

In this second stage, the EDD would be: 10000 – 9,750/10000 x 100 = 2.5%

Equity-based drawdown (EDD) goes up as your UPL increases. It warns you early; signals you to adjust your risk or refine your trading method.

To be on the safe side and not violate the overall drawdown limit for your program, you want to pay attention to each equity drawdown you “gain” and weigh it against the limits set by your prop firm (and maybe close your trades or adjust position size accordingly).

Let me bring the point home:

At RebelsFunding, if you get a $20k (starting balance) account and the daily drawdown (equity-based) for it is 5% (which resets around 21:00 UTC every day) – It means you should not lose more than 5% of the 20k ($1000) in open or closed trades in a trading day (24 hours before reset).

So, “for example, at 24:00 PM you have open and closed losses from that day at 4% and you have only 1% left before automatic shutdown of trades, then at midnight the maximum loss will reset, and you will have a room of 5% for the next day, however, the maximum loss limit will still limit you.”

As a beginner, if the DD for your account or program is 5%, risk within 0.5% to 1.5% (maximum) per day to protect it.

Benefits of equity-based drawdown

1. It provides an early warning system. Flags potential problems before they become severe.

2. It encourages you to look beyond just the account balance and consider the impact of unrealized losses on your account’s health.

Strategies that can help you trade safely under equity-based drawdown

1. Calculate your position size based on your current equity too and not just your account balance.

2. Always use stop-loss orders to exit losing positions automatically when the price reaches a predetermined level.

3. Take profit. This protects your profits and ensures your unrealized gains contribute to a higher current equity which protects you against potential drawdowns.