What it means
Drawdown is the fall from an equity peak to a later low. Maximum drawdown is the largest such fall over the period, in R, currency or percent.
Why traders use it
Drawdown is what you have to live through. A method with good expectancy but a drawdown you cannot tolerate will be abandoned at the worst moment. Recovery also needs more than the loss: a 20% drawdown needs a 25% gain to recover.
Chart examples
Peak-to-trough drawdown
How to identify it objectively
- 1Plot the equity curve.
- 2Track the running peak.
- 3Drawdown at each point = peak − current equity.
- 4The largest value is the maximum drawdown.
Bullish use
- 1Size positions so the expected maximum drawdown is survivable.
- 2Expect future drawdowns to be larger than past ones.
Bearish use
- 1A drawdown beyond your historical maximum may mean the method stopped working, or just bad luck; decide in advance which rule you will follow.
What confirms it
- Drawdown measured with costs and realistic fills.
What invalidates it
- Measuring only closed-trade equity when open trades went much deeper.
How a hypothetical setup is built
Entry
Not an entry rule.
Stop
Set a maximum drawdown at which you stop and review.
Target
Reduce size during drawdowns rather than increasing it.
A hypothetical illustration of how the concept is turned into a plan, not a recommendation. Practise it on a paper account first.
Related concepts
- Risk Management & StatisticsRisk of Ruin
- Risk Management & StatisticsExpectancy
- Risk Management & StatisticsPosition Sizing
- Full guide on The TradeskillRisk Management and Probability
Historical testing
The example uses the made-up 30-trade sequence: equity peaks at +4R and falls to −2R, a maximum drawdown of 6R, with a longest losing streak of 6 trades.
Limitations: when it fails
- Past maximum drawdown is not a ceiling.
- Short samples understate it.
- Percentage drawdown depends on position sizing.
Knowledge check
Pick an answer to see the explanation. Nothing is saved.