Drawdowns

What a drawdown is

An account doesn't go up in a straight line. It zigzags. A drawdown is how far it drops from its highest point, called the peak, before it climbs to a new high.

The line in the picture is an equity curve: a chart of the account's value over time. This pretend account started at $50,000, climbed to a peak of $56,000, then slid down to $50,400 before recovering.

• The drop: $56,000 minus $50,400 = $5,600.
• As a percent of the peak: $5,600 divided by $56,000 = 10%.

That's a 10% drawdown. The biggest drawdown in an account's whole history is called its maximum drawdown.

Notice something: the account never fell below where it started. It still felt awful. Drawdowns are measured from the peak, not from the start.

Every trader has them

Even a good strategy has losing streaks. Say you win 40% of your trades. Losing 5 in a row will happen often. Over a few hundred trades, losing 8 in a row at some point is more likely than not.

That's not because you're doing something wrong. That's just how chance works. Flip a coin enough times and you'll see long runs of tails.

So the question isn't "Will I have a drawdown?" It's "Will I survive it?"

Small risk saves you

• Risking 1% per trade, 8 losses in a row costs about 8%. Painful, but you're fine.
• Risking 5% per trade, 8 losses in a row costs about a third of the account. And remember the first lesson: lose a third, and you need about 50% just to get back.

How traders survive a drawdown

• A daily loss limit. For example: "If I lose 2% today, I stop for the day." No arguing with yourself.
• Smaller size when things go badly. Some traders cut their risk in half after a set drop, like 5% from the peak, until they recover.
• Stop and review. Read your trading journal. Are you following your rules? Or is the market just acting differently right now?
• No chasing. Trading bigger to win it all back in one shot is called revenge trading. It's how a 10% drawdown becomes a 40% one.

When it's more than bad luck

Sometimes a drawdown is normal bad luck. Sometimes it means the strategy stopped working because the market changed. That happens, even to professionals.

Knowing your usual drawdown size, from your journal or from testing, helps you tell the difference. If the drop gets much deeper than anything you've seen before, that's the time to stop and rethink, not to trade bigger.

Remember

• A drawdown is the drop from a peak to the lowest point before a new high.
• Losing streaks are normal. Plan to survive them.
• Small risk per trade keeps drawdowns small.
• A daily loss limit and no revenge trading protect you on bad days.