Comparing prop firms is an extremely difficult task.
There are so many of them, each with their own set of profit targets, drawdown rules, profit splits and prices.
My Ultimate Prop Firm Cheat-Sheet aims to make these comparisons much easier. And there’s a section that considers all of the parameters I’ve just mentioned into just one formula.
The Effective True Drawdown Multiplier
In this article I’ll explain what the ETDM is, the logic behind its calculation, and how you can use it in your own analysis of prop firms.
Bonus: If you want to find the best prop firm deals right now check out my prop firm discount codes pageTable of Contents
What is the Effective True Drawdown Multiplier (ETDM)?
The Effective True Drawdown Multiplier, or ETDM for short, is a calculation that aims to quantify the benefit of a prop firm challenge for a trader’s potential to earn, essentially the value for money of the challenge.
The calculation for ETDM contains many of the key factors for a prop firm challenge:
- Profit Targets
- Maximum Drawdown
- Account Size
- Evaluation Fee
- Profit Split
As a result, the ETDM can give a rating of a challenge at a glance, allowing for easy comparison between challenges, even of different account sizes.
Thanks to Andy in my discord server for coming up with this formula.
Key Terms For Understanding ETDM
To start, it’s important to acknowledge that these terms aren’t universally recognised, as online prop firms are in their infancy, so some of these terms never existed until we named them. Other traders / communities may have different names for the same concepts, so be aware of that too.
The reason I use these terms is simply to save time when using concepts that come up time and time again.
For example, it’s a lot easier to say True Backing, instead of saying ‘the total amount of money a trader can lose on the funded account before it is breached’ every time you want to make this comparison between firms.
True Backing is a component of the ETDM formula, so let’s have a look at why we use it and how to calculate it.
True Backing
When traders start with prop firms, they like to focus on the account size. If they are trading an $100k funded account they say they are ‘funded’, or ‘backed’ by $100k in capital. And when trading, they think that risking $1k per trade is sound risk management, because that’s risking only 1% of the account right?
Wrong. While the whole account size can be used as buying power, prop firm maximum drawdown rules mean you can’t use the whole account size as drawdown.
Typically prop firms have 8-12% maximum drawdown. Let’s assume 10% in this example.
An $100k funded account with 10% maximum drawdown can lose a maximum $10k from the initial account balance, meaning if equity drops below $90k at any point, the account is lost. This $10k is the True Backing, as mentioned before, ‘the total amount of money a trader can lose on the funded account before it is breached’.
As you’ve probably already worked out, this is simply calculated by Account Size multiplied by Maximum Drawdown
So, if a trader is risking $1k per trade with $10k True Backing, their ‘True Risk’ per trade is 10%. But what does ‘True Risk’ actually mean, and why do we use it?
‘True’ Risk, Reward, Profit & Loss
When working with prop firms, the amount we risk per trade shouldn’t be based on the entire account size, but the True Backing / Maximum Drawdown.
For example, if we want to take 5% ‘True Risk’ per trade on the funded account, we wouldn’t risk 5% of the account balance. Instead, we would risk 5% of the True Backing. Or, if we want the risk in terms of the initial account balance, we would risk 5% of the maximum drawdown. E.g. on the $10k account with 8% maximum drawdown:
- 5% of the $800 true backing = $800 * 5% = $40
- 5% of the 8% maximum drawdown = 0.4% account risk
- 0.4% of the $10k account = $40
If we keep risk fixed at $40 per trade, it will take 20 consecutive losses, or an overall -20R to lose $800, breaching the Maximum Drawdown limit. Because we’ve adjusted risk based on maximum drawdown, if we do the same to other accounts we can take trades with the same relative size, even if the accounts have completely different parameters.
For example, let’s say a $20k account with 10% maximum drawdown. If we wanted to take the same relative trade sizes as the $10k account with 8% maximum drawdown, what lot size would we use?
We wouldn’t just use double, meaning $80 risk per trade, because that would mean it would take 25 consecutive losses, or overall -25R to breach the $2,000 max drawdown of the account. So taking the same trades with double the lot size would breach the $10k account with 8% max drawdown first. Instead, we would calculate risk per trade using 5% True Risk, then work out how much to multiply our lots by.
- 5% of the $2,000 True Backing = $100
- 5% of the 10% maximum drawdown = 0.5% account risk
- 0.5% of the $20k account = $100 risk per trade
- $100 / $40 = 2.5x lot size required
So now if the $10k account risks $40 per trade, and the $20k account uses 2.5x the lot size of the $10k account (meaning $100 risk per trade), both accounts are risking 5% True Risk and therefore the trades are proportional. However, this means that winning or losing trades doesn’t equate to the same account size increases, but instead a proportional account size increase relative to maximum drawdown.
E.g. if you win a 2R trade taking 5% True Risk on both accounts. 2R means a 1:2 risk to reward ratio, meaning you win double what you have risked.
On the $10k account with 8% maximum drawdown 5% True Risk is 0.4% of the account, $40
- $40 * 2 = $80 won from trade
- 0.4% * 2 = 0.8% account size increase
- 0.8% / 8% = 10% True Reward (Return on the Maximum Drawdown or True Backing)
On the $20k account with 10% maximum drawdown 5% True Risk is 0.5% of the account, $100
- $100 * 2 = $100 won from trade
- 0.5% * 2 = 1% account size increase
- 1% / 10% = 10% True Reward (Return on the Maximum Drawdown or True Backing)
Because the True Risk is the same, the True Reward is the same, even though the account size increases are different.
True Risk and True Reward are used when referring to a single trade, like in this example True Risk is 5% and True Reward is 10%. In the context of a series of trades, we would say True Loss or True Profit. For example, if we take 10 trades at 2R and 5% true risk, with 6 being winners and 4 being losers, the True Profit would be 40%, meaning a 40% return on the Maximum Drawdown or True Backing.
- 10% Max Drawdown * 40% True Profit = 4% account increase
- $2,000 True Backing * 40% True Profit = $800 account profit
Understanding True Profit & Risk
When traders don’t understand True Profit, they can easily fall into overtrading. For example, if a trader made 2% on a Funded Account with 10% maximum drawdown, they may think they haven’t earned enough, after seeing other traders post 20-30% prop firm profits online. So they may continue to trade, losing the profits they have made and missing out on getting the evaluation fee refunded.
What the trader fails to understand is that 2% account profit on 10% Maximum Drawdown is 20% True Profit, which sounds a lot better right?
Also, those traders posting 20-30% account profit are have actually made 200-300% True Profit. Which, by no uncertain terms, requires huge risk taking, which means a high risk of blowing the funded account. In fact most traders who earn a large percentage on a funded account once will have blown multiple accounts to achieve this, and will almost definitely blow the account in the next cycle. The stats don’t lie.
Because a Funded Account is not your own money, there’s nothing wrong with risking high 10% or 20% True Risk per trade (1% and 2% of the account per trade with 10% maximum drawdown), but don’t be surprised if you blow your funded account doing this.
When you are first funded lower the risk initially, make a small amount of profit, and get your evaluation fee refunded. That way if afterwards you decide to increase risk and blow the account, at least you have not lost the money you spent on the evaluation fee.
Using True Backing
When calculating True Backing, account size still does matter, but only in combination with the maximum drawdown. This creates interesting cases, such as with the My Forex Funds $200k and the E8 Funding $250k accounts. While the E8 account is larger, My Forex Funds has 12% maximum drawdown and E8 funding has 8% maximum drawdown, meaning MFF has $4k more True Backing.
But True Backing doesn’t take into account the Profit Split, which is another key detail on the funded account. Profit split adjusted True Backing (PATB for short, calculated by multiplying the True Backing by the Profit Split) gives a more accurate representation of the potential for payouts from a Funded Account.
However, leaving the profit split out of the equation means True Backing has an easy to understand definition. Also, factoring in profit split doesn’t usually change much in terms of comparisons, because most firms have the same 80% profit split.
But for now if you understand True Backing, we can use it to calculate other terms.
True Backing per Dollar
On its own, True Backing gives a good indication of how much money a trader has to work with on the Funded Account, but to reach this point they have to pay an evaluation fee to take the prop firm challenge.
True Backing per Dollar (of evaluation fee) is calculated by dividing True Backing by the Evaluation Fee. Which when broken down, the formula is (Account Size * Maximum Drawdown) / Evaluation Fee.
True Backing per dollar can give an indication of the value for money of a prop firm challenge, but misses out an extremely important factor: the difficulty of the challenge. Even if you get a lot of True Backing for the price, this is no good if the challenge is extremely hard to pass. True Backing per Dollar also suffers from the same downside as True Backing of not taking the profit split into account.
So, the Effective True Drawdown Multiplier aims to improve upon True Backing per Dollar by factoring in Profit Split and Challenge Difficulty into its calculation.
How to Calculate ETDM
The ETDM calculates the size of the Profit Split adjusted True Backing of the funded account, in comparison to the Evaluation fee that has been increased by the required return of the prop firm challenge.
When broken down into all its parts, the full formula is:
If this doesn’t make sense right now don’t worry, I’ll break it down step by step.
Profit Split Adjusted True Backing (PATB)
If you read the ‘True Backing’ section earlier in this article you should understand Profit Split Adjusted True Backing, which I’ll call PATB for short. If you haven’t read it, I recommend you do, but I’ll give a quick explanation here anyway.
True Backing is the total amount of money that a trader can lose on the funded account before it is blown, calculated by multiplying Account Size by Maximum Drawdown. Then, to turn True Backing into PATB simply multiply it by the profit split.
E.g. with a $10k account with 8% maximum drawdown and an 80% profit split:
- True Backing = $10k * 8% = $800
- Profit Split Adjusted True Backing (PATB) = $800 * 80% = $640
What does PATB represent?
So now we know how to calculate PATB, why do we use it to calculate ETDM?
It’s because the PATB represents the potential to generate profit splits from a funded account. It is the profit split a trader would receive if they generated a 100% True Profit on a funded account. 100% True Profit means an 100% return on the Maximum Drawdown / True Backing.
- 100% return on 8% maximum drawdown = 8% account profit
- 8% profit on a $10k account = $800
- Alternatively, 100% return on the $800 True Backing = $800
- 80% profit split on $800 = $640 = the PATB we just calculated
So now we know this, the PATB can be used to calculate other values. In the same example, what about a 20% True Profit? We know PATB is $640 and represents and 100% return, so we can simply multiply $640 by 20% to get the profit split we would receive from a 20% True Profit.
- $640 * 20% = $128
And we can calculate this the long way too:
- 20% return on 8% maximum drawdown = 1.6% account profit
- 1.6% profit on a $10k account = $160
- Alternatively, 20% return on the $800 True Backing = $160
- 80% profit split on $160 = $128
This works for any True Profit percentage, even larger values like 150%.
The higher the PATB, the more a trader will receive in profit splits for every percentage of True Profit they earn on the Funded Account. Meaning the higher the PATB, the higher the potential to earn on the Funded Account.
The denominator (bottom) of the ETDM Formula
The denominator of the ETDM formula simply increases the evaluation fee by the required return to pass the challenge. This is the part that allows ETDM to factor in the cost of the challenge, as well as the difficulty.
For example, if a challenge cost $500 with 8% and 5% profit targets, and 8% maximum drawdown:
- $500*(1 + 8/8)*(1+ 5/8)
- = $500*(2)*(1.625) = $1,625
This value is the how large a personal trading account would be if you started with the evaluation fee and increased it by the required return to pass both phases of the challenge.
In reality, trading only the evaluation fee wouldn’t be able to proportionally match the trades on the challenge when in significant drawdown, due to insufficient buying power. That being said, a high leverage personal account with extra funds for buying power purposes could continue to proportionally match trades until the funded account is blown.
But we’re not arguing that you should trade the evaluation fee, we’re just calculating what the results of that could be, to use in our analysis.
The relationship between the components of ETDM
So now we know the numerator (top) of ETDM is Profit Split Adjusted True Backing, and the denominator (bottom) is the evaluation fee increased by the required return to pass the challenge, what does this signify?
As its name suggests, ETDM outputs a multiplier value. It shows how much larger the PATB of a challenge’s funded account is compared to its increased evaluation fee. This represents how much higher the funded account’s potential to earn is compared to a personal account the size of the increased evaluation fee. For example, a ETDM of 5x represents a 5 times higher potential to earn by passing the challenge instead of trading a personal account the size of the increased evaluation fee.
Let’s take the example before, but provide a few more details:
- One phase
- Profit Target: 10%
- Maximum Drawdown: 10%
- Cost: $500
- Account Size: $100k
- Profit Split: 80%
Right away, we can calculate ETDM as 8x. Let’s explain why.
- Profit Split Adjusted True Backing = ($100k * 10%) * 80% = $8,000
PATB is $8,000 so 100% True Profit on the funded account would yield an $8,000 profit split.
- Increased evaluation fee = $500 * (1+(10%/10%)) = $500 * 2 = $1,000
If you traded the $500 evaluation fee and produced the same return required to pass the challenge, the personal account would end up being $1,000.
As you can use the whole personal account as drawdown (100% max drawdown) and can withdraw all profit you make (100% profit split), the PATB of a personal account is simply the account size. Meaning if 100% True Profit was made on the $1,000 personal account, that trading would have generated an extra $1,000 in withdrawable funds.
So let’s compare the potential to earn on the funded account, or increased evaluation fee personal:
- Funded Account: $8,000 earned if 100% True Profit generated
- Personal: $1,000 earned if 100% True Profit generated
- $8,000/$1,000 = 8 = 8x ETDM
- = an 8 times higher potential to earn by passing the challenge instead of trading the evaluation fee.
This is the general idea of ETDM, now let’s have a look at comparing some prop firms with this measurement.
Comparing ETDM Values
The easiest way to compare ETDM is using the Ultimate Prop Firm Cheat-Sheet. The formulae used take into account the current discounted prices, and allow for quick comparison between firms and challenge sizes.
On average, ETBM increases the higher the account size, as prop firms offer better prices for higher priced challenges.
As a general rule of thumb, the higher the ETDM, the better value for money a prop firm challenge is. However, there’s certain limitations that we should be aware of when using ETDM in our analysis.
Limitations of ETDM
ETDM does a good job of summarising the key parameters of a prop firm challenge, but is far from perfect. Let’s have a look at some of the problems we may face when using ETDM
Ignoring Trading Conditions
Depending on your trading style, trading conditions on a prop firm can make or break your profitability. Traders with small stop losses will pay a lot in spreads and commission, as well as significantly increasing their losses if their stop loss is slipped. Traders like this will benefit from choosing a prop firm with the best trading conditions, even if that means a lower ETDM.
Ignoring Other Parameters
While ETDM has a large number of components, it’s impossible to fit all the key details of a prop firm challenge into one formula. Daily Drawdown is not included, and is a rule that can often be a huge factor for traders when choosing a prop firm. Daily drawdown type is important too, which also reminds us that maximum drawdown type is not a part of ETDM. If a challenge has relative drawdown, its ETDM value should be ignored, because the logic of the formula assumes maximum drawdown is static.
Ignoring Scaling
When calculating ETDM, initial profit split and drawdown parameters are used. Some firms offer scaling plans which increase these parameters, which ETDM does not account for. A notable case of this is My Forex Funds, which has the initial 75% profit split used in the formula, despite it being increased to 80% and 85% very early on.
Conclusion
With its limitations, you may wonder if there is any need for calculating ETDM, and if choosing a firm with a high ETDM actually affects a trader’s success with prop firms.
I’d argue that no matter how much analysis you do, the main component of your prop firm success is your trading skill. If you’re a very good trader, you can get away with choosing any firm and still make money. If you’re a completely losing trader, no matter what firm you choose, you will continue to lose money.
However, for the average trader, effective analysis of prop firms can help increase the chances of your success. By choosing a reputable firm with high ETDM you can ensure you are getting good value for money, allowing you to more easily make back the money you lost on failing challenges when you finally get funded.
Prop firm challenges are extremely complex, you’ll never be able to summarise them all into one formula. But ETDM can be used alongside other research to help find the best prop firm for you.
