Drawdown is the decline in an account, strategy or investment from a previous peak to a later low before a new peak is reached. Maximum drawdown is the largest peak-to-trough decline observed over a chosen period.
Key takeaways
- Drawdown measures loss from a prior equity high, not simply one losing trade.
- Maximum drawdown shows the deepest observed decline in a sample.
- Recovery becomes mathematically harder as drawdown increases.
- A high win rate does not automatically mean a strategy has low drawdown.
- Drawdown should be considered alongside return, sample size, leverage and risk per trade.
How is drawdown calculated?
If an account reaches $10,000 and later falls to $9,000 before making a new high, the drawdown from that peak is 10%. If it falls to $8,000, the drawdown is 20%.
The calculation is generally: (peak value - current value) ÷ peak value.
What is maximum drawdown?
Maximum drawdown is the largest peak-to-trough decline recorded during the measurement period. It helps describe how painful the worst historical decline was, but it does not tell traders what the worst future drawdown will be. A future period can always be worse than the historical sample.
Why does recovery get harder?
Losses and recoveries are asymmetric because the recovery is calculated from a smaller base. A 10% drawdown requires roughly an 11.1% gain to recover. A 20% drawdown requires 25%. A 50% drawdown requires 100% simply to return to the original peak.
This is one reason protecting capital matters more as losses deepen.
Drawdown vs losing streak
A losing streak counts consecutive losses. Drawdown measures the decline in equity from a previous high. A strategy can experience drawdown through a mixture of losses, small wins and break-even trades rather than one clean losing streak.
Why win rate is not enough
A strategy can win often but occasionally suffer large losses. Another can win less often while keeping losses small and winners larger. Both could display similar returns while producing very different drawdown profiles.
That is why traders should evaluate win rate and risk-to-reward together rather than treating one percentage as the whole story.
How does leverage affect drawdown?
Greater position size magnifies account movement. If the underlying strategy experiences the same sequence of outcomes, higher leverage can turn a manageable drawdown into a severe one. Leverage changes the account impact of normal strategy variance.
Why sample size matters
A short test may never encounter the market conditions that produce the true worst-case sequence. Maximum drawdown measured over 20 trades is not comparable in reliability to a much larger and more varied sample without additional context.
How should traders use drawdown?
Drawdown is best used as a risk metric rather than a prediction. It helps compare how different approaches behave when they are not performing well and whether the level of account fluctuation is realistic for the trader using them.
Bottom line
Return tells you what was made. Drawdown helps explain what had to be endured along the way. A serious evaluation of trading performance should consider both.
Continue with Trading Expectancy Explained and What Is Leverage?.
This article is educational only and is not financial advice. Historical drawdown does not define future maximum loss.