Drawdown: definition

The fall from the high

Drawdown measures an account's fall from its previous high. An account that went from 10,000 to 12,000 euros, then fell back to 10,800, is in a 10% drawdown: 1,200 euros lost since the 12,000 peak. Maximum drawdown is the largest fall observed over a whole period.

The asymmetry of recovery

Losses and gains don't offset in percentage terms. After a 10% loss, you need to gain 11.1% to get back to the start; after 20%, 25%; after 50%, 100%. The deeper the drawdown, the harder it becomes to get out of it.

That's why risk management first seeks to limit the depth of drawdowns, before trying to maximise gains.

A strategy's expected drawdown

Even a winning strategy has losing streaks. With a 50% win rate, a run of eight consecutive losses is nothing unusual over a few hundred trades. At 1% risk per trade, it costs about 8%; at 3%, more than 21%. A Monte Carlo simulation lets you estimate the drawdown to expect before you start.

Prop firms impose a maximum drawdown, fixed or trailing: exceeding it loses the account, whatever the final result.

Frequently asked questions

What's the difference between a fixed and a trailing drawdown?

A fixed drawdown is measured from the starting capital. A trailing drawdown is measured from the highest point reached: it rises with gains and never comes back down, which makes it more demanding.

What is a good maximum drawdown?

There is no universal threshold: it depends on the target return and each person's tolerance. The ratio of annual return to maximum drawdown lets you compare two strategies.