Drawdown

Drawdown measures how much an account (or a strategy) has lost from its highest point before recovering. It is a better measure of pain than the final result, because it shows what you would have had to sit through along the way.

Key terms

• Current drawdown: how far the account is now below its previous peak.
• Maximum drawdown: the largest peak-to-trough fall over the period measured.
• Recovery: the return to a new high, which may take much longer than the fall.

The recovery problem

Losses and gains are not symmetrical. To recover from a drawdown you need a larger percentage gain than the percentage you lost:

• a 10% drawdown needs about an 11% gain to recover;
• 25% needs about 33%;
• 50% needs 100%;
• 75% needs 300%.

Worked example

An account grows from 5,000 to 6,000 euros, then falls to 4,500 before recovering. The maximum drawdown is 1,500 euros from the 6,000 peak, or 25%, even though the account is still only 10% below where it started. To get back to 6,000 it needs a 33% gain from 4,500.

Practical notes

• Risking a small, fixed percentage per trade keeps drawdowns manageable through losing streaks. Ten consecutive losses at 1% each cost about 10%; at 5% each, about 40%.
• Backtests and track records often understate future drawdowns. Treat a published maximum drawdown as a minimum to plan for.
• Correlated positions can deepen drawdowns. See correlation.

See drawdown and recovery and position sizing.