By Marco BösingWhat Is Drawdown?
Drawdown (DD) measures the decline in account equity from the most recent peak to the lowest point before a new high is reached. It is typically expressed as a percentage and is one of the most important metrics for evaluating trading strategies and systems.
A drawdown of 20% means: starting from the highest account balance, the account fell by 20% before recovering. The maximum drawdown (Max DD) is the largest decline ever recorded across the entire trading history.
Types of Drawdown
Absolute Drawdown
The difference between the starting capital and the lowest account balance ever reached. Shows how far the account fell below the initial capital.
Maximum Drawdown (Max DD)
The largest decline from an equity peak to an equity trough across the entire trading history. This is the most commonly used drawdown metric.
Relative Drawdown
The maximum drawdown expressed as a percentage of the equity peak. Important for comparing strategies with different account sizes.
Why Is Drawdown So Important?
Drawdown is critical for several reasons:
Mathematical Asymmetry of Recovery
A 50% drawdown requires a 100% return to restore the original account balance. This non-linear relationship makes deep drawdowns particularly dangerous:
| Drawdown | Recovery Required |
|---|---|
| 10% | 11.1% |
| 20% | 25.0% |
| 30% | 42.9% |
| 50% | 100.0% |
| 75% | 300.0% |
Psychological Impact
Deep drawdowns are emotionally devastating. A trader who has lost 30% of their account is under enormous pressure — increasing the likelihood of tilt, revenge trading, and further errors.
Strategy Evaluation
Two strategies with identical total profit are not equivalent if one has a maximum drawdown of 10% and the other 40%. The ratio of return to drawdown — often measured as the Calmar Ratio or MAR Ratio — is a better indicator than raw return.
How to Control Drawdown
1. Position Sizing
The most effective method for drawdown control. A maximum risk of 1-2% per trade limits drawdown to manageable levels even during extended losing streaks.
2. Daily and Weekly Loss Limits
Set firm boundaries: for example, a maximum of 3% loss per day and 6% per week. When reached, trading stops.
3. Monitor Correlation
Multiple simultaneous positions in correlated markets can multiply drawdown. The total risk across all open positions must be considered.
4. Strategy Diversification
Different strategies or market directions can smooth overall drawdown, since not all strategies lose simultaneously.
Frequently Asked Questions
What Is an Acceptable Maximum Drawdown?
This depends on the trader and strategy. For most active traders, a Max DD of 10-20% is considered acceptable. Professional funds often target a Max DD below 10%. A Max DD exceeding 30% is psychologically nearly unbearable for most traders.
How Do I Calculate My Drawdown?
Drawdown = (Peak - Trough) / Peak x 100. Example: Peak $50,000, lowest point afterward $42,500. Drawdown = (50,000 - 42,500) / 50,000 x 100 = 15%.
Can Backtesting Predict Maximum Drawdown?
Backtesting reveals the historical Max DD, but the future Max DD will very likely exceed it. A rule of thumb: expect at least 1.5 times the Max DD observed in backtesting during live trading.