Drawdown is the least flattering number in trading and the most informative one. It measures how far account value has fallen from a previous high, and unlike a single loss it describes the conditions you actually have to trade in. It also behaves asymmetrically in a way that surprises most people the first time they work out the arithmetic.
What it measures
A peak is any previous high in equity. A trough is the low reached afterwards. Drawdown is the fall between them, normally expressed as a percentage of the peak. The important detail is that it counts while losses are open, so a position carrying four hundred dollars of unrealised loss reduces equity whether or not it has been closed, and a trader who only counts realised losses is understating the number that a stop-out would actually use.
Because the calculation is against equity rather than margin, drawdown includes the effects of swap, commission and spread widening. Two traders with identical entries and different account currencies can show different drawdowns purely from conversion.
The asymmetry
Here is the arithmetic, worked with round numbers for illustration. A fall of ten percent leaves ninety behind, and recovering to one hundred requires a gain of eleven and a half percent, because that gain is calculated on the smaller base.
It steepens quickly. A twenty-five percent fall needs a thirty-three percent rise to repair. A fifty percent fall needs a hundred percent. A seventy percent fall needs a gain of more than three hundred percent on what remains.
The consequence is not motivational, it is numerical: the return required to recover grows faster than the loss deepens, and it does so without any help from the quality of the trades being taken. A strategy whose average winning return per month is fixed does not become more productive because the account is smaller. It simply needs more months, and it needs them to be good ones.
A loss is a subtraction. A recovery is a percentage of a smaller number. Those are not the same task.
Why deep drawdowns change behaviour
This part is not arithmetic, but it matters as much. A trader at five percent down is usually still following the plan. The same trader at forty down is choosing between a plan that would take a long time to repair the damage and a larger position size that would repair it faster on paper. The second option is the one that turns a bad quarter into an ended account, and it is attractive precisely because the arithmetic above makes the honest route feel slow.
The defensible response to a deep drawdown is boring: reduce size, verify that the reason for the losses is understood, and accept the recovery period the maths dictates. Anyone offering a way around that is selling something else.
Four habits that deepen drawdown
- Sizing to the account rather than to the stop. Fixed lots regardless of distance means every trade carries whatever risk the market happened to offer that day.
- Averaging into a losing position. Adding to a trade that has already invalidated its own entry increases both the exposure and the loss at the eventual stop.
- Uncorrelated in name only. Three long positions in currencies that move together are one position with three sets of costs, and they fall together.
- Widening a stop to avoid realising a loss. The loss was already in the equity figure; widening converts a defined one into an open-ended one.
Measuring your own
Track peak equity, not balance, and record the worst fall you have personally caused rather than the one your strategy could cause in theory. The gap between those two numbers is usually about sizing and about the four habits above, and it is the most useful piece of self-knowledge available without changing anything about the market.
Risk disclosure
The percentages in this article are illustrative arithmetic, not forecasts and not typical results for any trader. Drawdown is a normal feature of trading and can exceed expectations. Leveraged positions can be closed automatically by a broker when margin falls too low, crystallising losses at prices worse than intended. This is educational material and is not financial advice.