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TRADING GLOSSARY

Drawdown: measuring the pain of losses

Drawdown is the decline from a peak in your trading account to a subsequent low point. If your account reaches $10,000 and then drops to $8,000, your drawdown is $2,000 or 20%. Drawdown measures the real cost of losing periods and is one of the most important metrics for evaluating any trading strategy.

Types of drawdown

Maximum drawdown (MDD) is the largest peak-to-trough decline in your account history. It represents the worst losing streak you have experienced. Relative drawdown is the maximum drawdown expressed as a percentage. Recovery time is how long it took to recover from the drawdown back to a new equity high.

The math of recovery

What makes drawdowns so dangerous is the asymmetric math of recovery. A 10% drawdown requires an 11.1% gain to break even. A 20% drawdown requires a 25% gain. A 50% drawdown requires a 100% gain — you need to double your money just to get back to where you started. A 90% drawdown requires a 900% gain.

This math is why professional traders obsess over drawdown management. Keeping drawdowns small (under 20%) means recovery is achievable. Allowing large drawdowns (50%+) makes recovery nearly impossible.

Managing drawdown

Key strategies for managing drawdown include using proper position sizing (risking 1-2% per trade), using stop losses on every trade, reducing position size during losing streaks, diversifying across uncorrelated strategies, and having a maximum drawdown limit at which you stop trading and reassess.

AskTrade’s Risk Assessment Agent calculates projected drawdown scenarios for every trade it analyzes, helping you understand the worst-case outcome before you enter.

Disclaimer: This is for educational purposes only and does not constitute financial advice. Trading involves significant risk of loss.