What's the Difference? Daily vs. Max Drawdown
In funded evaluations (prop firm challenges), both Daily Drawdown and Max Drawdown are critical rules that, if breached, will typically result in failing the evaluation. They are designed to measure and limit a trader's risk.
Here's the difference:
1. Daily Drawdown (DD) / Daily Loss Limit (DLL)
What it is: The maximum amount of money your account can lose in a single trading day.
Calculation Basis: This is crucial and varies by firm. It's usually calculated based on your previous day's closing balance or previous day's closing equity. Some firms might use the start-of-day balance.
Example: If your daily drawdown limit is 5% and your previous day's closing balance was $100,000, you cannot let your equity (including open positions) drop below $95,000 during the current trading day.
If you made a profit and your balance at the start of the next* day is $102,000, your daily loss limit for that new day would be 5% of $102,000, meaning your equity cannot drop below $102,000 - $5,100 = $96,900.
Reset: The daily drawdown limit resets at the end of each trading day (according to the firm's server time).
Purpose: To prevent a trader from having a single catastrophic day that wipes out a significant portion of the account. It encourages consistent, controlled trading on a day-to-day basis.
Measurement: Often measured against equity, meaning it includes both closed trades and unrealized P/L from open positions.
2. Max Drawdown (MDD) / Overall Drawdown / Trailing Drawdown
What it is: The maximum amount your account can lose from its highest recorded balance or equity point throughout the entire evaluation period.
Calculation Basis: This also varies, but it's commonly one of two types:
Static/Fixed Max Drawdown: Calculated based on your initial account balance. If your initial balance is $100,000 and the max drawdown is 10% ($10,000), your equity can never drop below $90,000. This is simpler but less common for challenges.
Trailing Max Drawdown: This is more common. The max drawdown limit "trails" your highest achieved closed equity.
Example: Account starts at $100,000 with a 10% ($10,000) trailing max drawdown. Your absolute minimum equity is initially $90,000.
If your account equity (after closing trades) reaches a new high of $105,000, your new max drawdown threshold becomes $105,000 - $10,000 = $95,000.
If your equity then drops to $102,000 and then goes up to $103,000, your max drawdown threshold remains* at $95,000. It only moves up when a new peak closed equity is achieved. It does not trail back down if you incur losses from your peak.
Reset: The max drawdown limit generally does not reset during the evaluation period.
Purpose: To ensure that even if a trader has good individual days, they don't accumulate overall losses that put the firm's capital (or simulated capital) at excessive risk. It measures the largest peak-to-trough decline.
Measurement: Usually measured against equity, including open positions.
Why are they important for funded evaluations?
Risk Management: Prop firms use these rules to filter out traders who cannot manage risk effectively.
Consistency: They encourage traders to aim for consistent profits rather than taking huge gambles.
Capital Protection: Even in simulated environments, these rules mimic how firms protect real capital.
Crucial Tip: Always read the specific rules of the prop firm you are considering. The exact calculation methods (e.g., balance vs. equity, how "end of day" is defined, how trailing drawdown is calculated) can vary slightly between firms, and these details are critical to your success.