How drawdown works
Drawdown is the fall from a portfolio’s peak equity to its current value, expressed as a percentage. Max drawdown is the worst peak-to-trough drop recorded over a period. It is the single most honest measure of a strategy’s pain, because it captures what you actually had to sit through, not the smoothed average return that backtests like to advertise.
Worked example
Your account peaks at $10,000, then falls to $7,000 before recovering. That is a 30 percent drawdown. The recovery is harder than the fall: from a 30 percent drawdown you need a 43 percent gain just to get back to even, because the gain is calculated on the smaller balance. A 50 percent drawdown needs a 100 percent gain to recover. This asymmetry is why limiting drawdown matters more than chasing returns.
How to control drawdown
Drawdown is governed by position sizing and correlation, not by being right more often. Risk one to two percent per trade, treat correlated positions as one, and cut leverage when volatility rises. Negative balance protection on a Volity retail account caps the absolute worst case at your deposit, but a 50 percent drawdown is recoverable only if it does not keep happening.
Why it matters
Most traders quit during a drawdown, not after a loss, because a deep equity dip breaks confidence and discipline at the same time. A strategy you cannot hold through its normal drawdown is the wrong strategy for you, however good the average return looks. Judge any system by its worst stretch, then size so you can survive it. Related: risk-reward ratio.
Read the full breakdown in our forex trading guide.
