What is the difference between Balance-Based Drawdown and Equity-Based Drawdown?

Balance-Based Drawdown and Equity-Based Drawdown are two distinct methods for managing risk in trading, each with different ways of calculating your account balance and triggering the loss limit.

Balance-Based Drawdown: In this method, the drawdown is calculated based on the initial account balance. For instance, if your trading account starts with $100,000, all drawdowns are calculated against this $100,000, regardless of any gains or losses during the trading day.

Equity-Based Drawdown: This method tracks your account in real-time, adjusting based on current profits or losses. Essentially, your account balance fluctuates throughout the day as trades succeed or fail, and the drawdown is calculated based on this constantly changing equity.

To simplify: Balance-Based Drawdown takes a snapshot at the start and end of the day, while Equity-Based Drawdown updates in real time.

Let’s break it down with three examples:

Scenario 1: You have $100,000 in your account with a 5% daily loss limit, which is $5,000. During the day, your open trades show a $5,000 loss.

  • Balance-Based Drawdown: Here, your daily limit is fixed at $5,000. If your open trades reflect a $5,000 loss, you hit your daily loss limit and can’t trade further for the day.
  • Equity-Based Drawdown: In this case, your account drops to $95,000 as the loss occurs, hitting your daily limit. The moment your balance hits $95,000, you reach your daily loss limit.

Conclusion: In both cases, a $5,000 loss triggers the limit, though Balance-Based Drawdown works with fixed figures, while Equity-Based Drawdown reacts to real-time losses.

Scenario 2: You start with $100,000 and make a $1,000 profit during the day. However, your open trades show a $5,000 loss.

  • Balance-Based Drawdown: Since your account balance was $100,000 and you have a $1,000 profit, you can lose up to $6,000 for the day ($5,000 limit + $1,000 profit). Even with the $5,000 loss, you remain within your allowable loss for the day.
  • Equity-Based Drawdown: Your balance becomes $101,000 with the $1,000 profit, and even with a $5,000 loss, your daily loss limit is not exceeded because your account balance still holds at $96,000.

Conclusion: Equity-Based Drawdown gives more flexibility in this case, considering the profits made, while Balance-Based Drawdown offers a fixed limit based on the initial account.

Scenario 3: Yesterday, you lost $1,000 and start today with $99,000 and the same 5% loss limit.

  • Balance-Based Drawdown: Each day is treated independently, so even with yesterday’s loss, your limit remains $5,000 for the new day.
  • Equity-Based Drawdown: Your new daily loss limit is now 5% of $99,000, which is $4,950, since the previous day’s loss is considered.

Conclusion: Balance-Based Drawdown offers a fresh start every day, while Equity-Based Drawdown adjusts based on previous performance, limiting your flexibility.

In summary, Balance-Based Drawdown is often seen as more advantageous for traders because it provides a consistent loss limit based on the initial account balance. At Instant Funding Prop Firm, the drawdown is calculated using the Balance-Based Drawdown method.

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