What is drawdown in trading?

How it’s calculated

Take the highest peak your account reached and compare it with the current value, or with the low that followed:

Drawdown = (peak − low) ÷ peak

Hypothetical example: your account grows from $10,000 to $12,000 and then falls to $9,600. The drawdown is (12,000 − 9,600) ÷ 12,000 = 20%. Even though you are only 4% below your initial deposit, drawdown is measured from the peak, because that gain was already yours.

Maximum drawdown is the largest drop the account recorded over an entire period. You can see it clearly on the equity curve, the chart of your balance trade by trade.

The asymmetry: recovering costs more

A percentage loss requires a larger gain to get back to where you started, because the recovery is calculated on a smaller base:

• A 10% drop requires an 11.1% gain.
• A 20% drop requires a 25% gain.
• A 30% drop requires a 42.9% gain.
• A 50% drop requires a 100% gain.

In the earlier example, going from $9,600 back to $12,000 requires a 25% gain. That’s why protecting capital matters as much as growing it. The relationship isn’t linear: every additional point of decline demands an ever larger recovery effort.

Not just how deep, but how long

Besides depth, duration matters: how long it takes the account to get back to its previous peak. A 15% drawdown that recovers in three weeks feels very different from one that lasts eight months. That stretch is when most traders abandon their plan or change their rules blindly, sometimes right before the strategy recovers.

That’s why, when comparing two strategies with the same return, the one with the smaller maximum drawdown and shorter duration is usually easier to stick with. And if you test a strategy on historical data, expect the real drawdown to be larger than the historical one: the future tends to bring streaks the sample didn’t have.

What controls drawdown: risk per trade

Losing streaks happen to every strategy. What decides the size of the drawdown is how much you risk on each trade.

Hypothetical example: ten losses in a row risking 1% of the account on each leave a drawdown of about 9.6%. The same ten losses risking 5% leave a drawdown of around 40.1%, which would require a gain of around 67% to recover. The strategy is the same; position size changes everything.

How it’s used in practice

Many traders set a drawdown limit in their trading plan: if the account falls a certain percentage from its peak, they cut their size or stop trading to review. Another common practice is to halve risk per trade for as long as the drawdown lasts and return to normal size once the account recovers. In funded accounts, drawdown is an elimination rule: exceeding it ends the account.

A frequent mistake is measuring only closed losses. Real drawdown includes open positions that are going against you, even if you haven’t closed them yet.