How it works
Drawdown measures pain. Equity rises, then falls, then rises again. Each fall from a prior high is a drawdown. The percentage matters more than the dollar amount because recovery is asymmetric: a 50 percent drawdown takes a 100 percent gain to recover, not 50 percent.
Example
A $10,000 account hits $15,000 then falls to $9,000. The drawdown is $6,000, or 40 percent of the peak. To get back to $15,000 the account needs a 67 percent gain on the current $9,000 balance. That is the asymmetry that ruins overleveraged accounts even when the strategy is fundamentally sound.
Max vs. average drawdown
- Max drawdown: single worst fall in the testing or trading period. Use it for tail-risk sizing.
- Average drawdown: mean of all drawdowns. Reflects normal day-to-day volatility of the equity curve.
- Time in drawdown: how long the account stayed below the prior peak. A strategy can have a small max drawdown but spend most of its life under water.
Why it matters
Drawdown is the variable that decides whether you stick with a strategy or abandon it. A 25 percent backtest drawdown that compounds to 35 percent live is the line where most retail traders quit. Size positions so the realistic drawdown stays inside what you can hold without revenge-trading.
