The loss of leverage is often forgotten about when considering taking a loss on
a losing position. The realisation of the loss often results in a substantial loss
because the trader doesn't want to realise it. Effectively what happens during a
drawdown is that your leverage in the position is increasing, with a decreasing
principal. There is a time when you will run out of leverage and be forced to take
the loss, by way of at least a margin call. In this case you have to enter a maximum
leverage trade to attempt to recoupe the losses. Often this is what actually ocurs
after a drawdown. It results in substantially more risk being taken on by a trade,
undue risk which will ultimately result in the account blowing up (or perhaps more
aptly away). I have done this a few times, and it leaves you with a, what just happened
type of feeling. In anycase its a lesson worth experiencing at least once in your
trading life. The plot below illustrates how much gain you need when you have reduced
your account by the drawdown displayed. You soon realise its wise to keep drawdowns
to single digit levels. Permalinked
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