What is Drawdown in Trading?
Drawdown is the percentage or dollar decline from your account's highest point (peak equity) to its lowest point (trough) before recovering to a new high. It measures the worst-case loss you've experienced.
How It Works
If your account peaks at $10,000, then drops to $7,500 before recovering, your maximum drawdown is 25% ($2,500). Drawdown can be measured as a percentage (25%) or in absolute dollars ($2,500). Every trading strategy has a characteristic drawdown profile. Trend-following systems tend to have deeper but less frequent drawdowns. Mean-reversion systems have shallower but more frequent ones. No strategy avoids drawdown entirely. Recovery from drawdown requires disproportionate gains: a 50% drawdown needs a 100% gain to recover. A 25% drawdown needs a 33% gain. That asymmetry is why capital preservation matters more than chasing returns.
Why It Matters
Drawdown is one of the most important measures of trading risk. A strategy that returns 50% per year but routinely draws down 40% is far riskier than one returning 20% with a 10% max drawdown. Professional fund managers are evaluated by their drawdown profiles as much as their returns.
Common Mistake
Increasing position size during a drawdown to 'win it back faster.' A 25% drawdown requires a 33% gain to recover, and oversizing during a losing streak compounds the damage. Recovery requires the same discipline that prevents deep drawdowns in the first place.
Example
Your account grows from $5,000 to $8,000 over three months, then a losing streak drops it to $6,400. Your max drawdown is 20% ($1,600 from the $8,000 peak). You'd need a 25% gain from $6,400 to get back to $8,000.
Stoic Insight
Drawdowns reveal whether a system has real edge or was riding luck. Use the drawdown to examine the process, not to abandon it. Marcus Aurelius: 'The impediment to action advances action. What stands in the way becomes the way.'
Related Terms
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