The Big Idea
Drawdown is how much your trading account drops from its highest point before it starts going back up. It measures the PAIN of trading. The losses you have to go through between the good times.
Think of it like climbing a mountain. You don’t go straight up. You hike up, then the trail goes down a little, then back up higher, then down a bit, then up even higher. That “going down” part is like drawdown. It’s the dip before you reach a new peak.
Every trader has drawdowns. Even the best traders in the world. It’s a normal part of trading. But HOW BIG your drawdowns are can make or break your trading career.
How Drawdown Works
Let’s say your trading account has this journey:
- You start with $10,000
- You trade well and grow it to $12,000
- You have a bad stretch and drop to $9,000
- You recover and climb to $15,000
Your DRAWDOWN was from $12,000 down to $9,000. That’s $3,000 off the peak, or 25% of your highest value.
When you hit $9,000, you were “in drawdown.” When you went back above $12,000, you came “out of drawdown.”
Your MAX drawdown for this journey was $3,000 or 25%. Max drawdown is often expressed as a percentage because it’s easier to compare across different account sizes.
Why Drawdown Matters More Than Profits
Here’s something that surprises a lot of beginners. Your drawdown is often MORE important than your profits!
Why? Because big drawdowns kill trading careers. Here’s how.
Reason 1: It’s Hard to Recover
If you lose 50% of your account, you don’t need to make 50% back. You need to make 100% back! Here’s the math:
- Start with $10,000
- Lose 50% → Down to $5,000
- To get back to $10,000, you need to double your money
- That’s a 100% gain!
The bigger the drawdown, the harder the recovery.
| Drawdown | Gain Needed to Recover |
|---|---|
| 10% | 11.1% |
| 25% | 33.3% |
| 50% | 100% |
| 75% | 300% |
| 90% | 900% |
See how it gets insane fast? A 10% drawdown is easy to recover from. A 75% drawdown is nearly impossible.
Reason 2: It Messes With Your Head
Big drawdowns don’t just hurt your account. They hurt your BRAIN. When you’ve lost 30% of your money, you start making worse decisions. You get scared. You take trades you shouldn’t. You skip trades you should take. Your judgment gets clouded.
Small drawdowns (like 5-10%) are annoying but don’t usually mess with your head. Big ones (30%+) can change how you trade forever, often in bad ways.
Reason 3: You Might Quit
After a huge drawdown, a lot of traders just give up. They stop trading. The pain is too much. Even if their strategy would have eventually recovered, they never find out because they quit.
Keeping drawdowns small keeps you in the game long enough to succeed.
Types of Drawdown
Current Drawdown
How far below your peak you are RIGHT NOW. If your peak was $15,000 and you’re at $14,000, your current drawdown is $1,000 or about 6.7%.
Max Drawdown
The WORST drawdown you’ve ever had. Even if you recovered, that number stays in your records as the biggest dip you’ve experienced. This is the scariest number for most strategies.
Average Drawdown
The average of all your drawdowns over time. Gives you a sense of what “normal” pain looks like for your strategy.
Drawdown Duration
How LONG you spent in drawdown before getting back to new highs. Some strategies have small but long drawdowns. Others have big but quick drawdowns. Both matter.
What Causes Big Drawdowns
Cause 1: Losing Streaks
Even a good strategy has losing streaks. Five losses in a row is normal. Ten losses in a row is possible. If each loss is big, you get big drawdowns.
Cause 2: Risking Too Much Per Trade
This is the big one. If you risk 10% per trade, a 5-trade losing streak wipes out 50% of your account. If you risk 1% per trade, the same streak only causes a 5% drawdown.
Position size is the #1 driver of drawdown size.
Cause 3: Revenge Trading
You take a loss. You get mad. You try to make it back by taking extra trades with extra size. They lose too. Now you’re really mad. You size up more. Now you’re really, really down. This is how 5% drawdowns become 50% drawdowns in days.
Cause 4: Breaking Your Rules
You usually risk 1%. You’re excited about a “sure thing” and risk 10% just once. It loses. Now you have a 10% drawdown from one trade, same as ten normal losses would have caused.
Cause 5: Market Crashes
Sometimes the market does something wild and everyone gets hurt. Gaps, flash crashes, sudden news. Even with good rules, you can take losses during these events.
How to Keep Drawdowns Small
Tip 1: Follow the 1% Rule
Never risk more than 1% (or 2% max) of your account on any single trade. With 1% risk, even ten losses in a row only causes a 10% drawdown. Manageable.
Tip 2: Use Stop Losses Every Time
Stop losses make your worst case predictable. Without them, one bad trade can become a huge drawdown.
Tip 3: Don’t Add to Losers
When a trade is losing, resist the urge to “average down.” This often turns small losses into huge ones.
Tip 4: Size Down When You’re Down
If you’ve had a few losses in a row, REDUCE your position size temporarily. Get smaller while you figure out if it’s a streak or a real problem. You can always size up again later.
Tip 5: Take Breaks
When you hit a certain drawdown level (say 10% or 15%), consider stopping trading for a day or a week. Come back with fresh eyes.
Tip 6: Know Your Strategy’s Normal Drawdown
If your backtests show that your strategy normally has 15% drawdowns, don’t freak out at 10%. But if you hit 25%, that’s a sign something might be wrong.
Drawdown and Strategy Evaluation
When comparing trading strategies, don’t just look at total profits. Look at drawdown too.
Example:
- Strategy A: Makes 30% per year, with 15% max drawdown
- Strategy B: Makes 50% per year, with 60% max drawdown
Which is better? Strategy A! Here’s why:
With Strategy B, you’d have moments where you lose 60% of everything. Most people can’t stomach that. They’d quit before the recovery. And a 60% drawdown needs a 150% gain to recover!
Strategy A makes less, but the ride is smoother. You can actually stick with it. You sleep at night. And steady 30% gains compound beautifully over time.
Pros often say: “Smooth equity curves beat big returns with violent swings.” Drawdown is how you measure the smoothness.
The Psychological Side of Drawdown
Here’s something important. Drawdowns don’t just hurt your account. They hurt YOU.
Studies show that losing money feels TWICE AS BAD as making the same amount feels good. So a 20% drawdown feels way worse than a 20% gain feels good. This is called “loss aversion” and it’s built into human brains.
That’s why drawdowns are so dangerous psychologically. They create:
- Fear: You start avoiding trades you should take
- Anger: You try to “get back at the market”
- Desperation: You take bigger, riskier trades
- Self-doubt: You question everything about your strategy
- Burnout: You lose motivation to trade at all
Keeping drawdowns small isn’t just about math. It’s about staying SANE enough to keep trading.
Common Mistakes Beginners Make
Mistake 1: Not Tracking Drawdown
Many beginners only track profits. They celebrate their account high but don’t notice how far they’ve dropped since. You can’t manage what you don’t measure.
Mistake 2: Accepting Huge Drawdowns as “Normal”
“All traders have 50% drawdowns!” No they don’t. Professional traders target much smaller drawdowns. If you’re regularly hitting 30%+ drawdowns, something is wrong.
Mistake 3: Sizing Up During Drawdown
The dumbest thing you can do. You’re already losing, so you risk more to “make it back faster.” This turns 10% drawdowns into 50% drawdowns in days. Always size DOWN during drawdowns, never up.
Mistake 4: Ignoring Drawdown in Backtests
A strategy that makes 100% returns but has 70% drawdowns is almost impossible to trade live. Your emotions won’t let you. Always check drawdown when evaluating strategies.
Mistake 5: Quitting at the Bottom
Some traders quit during big drawdowns, right before their strategy would have recovered. If your strategy is sound, stick with it through normal drawdowns.
The Big Picture
Drawdown is the tax you pay for trading. Even great traders have drawdowns. The goal isn’t to eliminate them (impossible). The goal is to keep them SMALL enough that:
- You can mentally handle them
- You can recover from them
- You can keep following your strategy through them
Here’s what to remember:
- Drawdown is how far your account drops from its peak
- Big drawdowns take exponentially more gains to recover
- A 50% drawdown needs a 100% gain to break even
- Small risks per trade keep drawdowns manageable
- Psychological pain from drawdowns is a bigger threat than the money itself
- Compare strategies on BOTH returns and drawdowns
- Never size up during a drawdown. Size DOWN if anything.
Here’s a wise saying: “You can survive a lot of small losses. You can’t survive a big one.”
The goal of trading isn’t to make the most money possible. It’s to make steady money while never having a drawdown big enough to end your career. Master that, and you can trade for decades.
Related Terms
- What Is a Stop Loss? — The #1 tool for limiting drawdowns
- What Is Position Size? — How position size determines drawdown size
- What Is Risk of Ruin? — The most extreme form of drawdown
- What Is Balance and Equity? — The numbers drawdown tracks
- What Is Trading Psychology? — Why drawdowns hurt mentally
← Back to the Complete Trading Terms Glossary
Focus on the process. Trust the stats. Stay consistent.