Risk management
Maximum Drawdown: Definition, Recovery Math and Limits
Maximum drawdown explained: how to measure peak-to-trough losses, why recovery needs a larger gain, drawdown duration, and setting limits and prop-firm rules.
Maximum drawdown is the largest fall in account equity from a peak to a subsequent low, before a new peak is made. It is one of the most practical risk numbers a trader can track, because it describes the worst stretch you would have had to sit through. Returns tell you what a strategy earned. Maximum drawdown tells you what it cost to stay in.
How maximum drawdown is measured
Track the running peak of equity. At every point, drawdown is the distance between current equity and that peak, expressed in money or as a percentage of the peak. Maximum drawdown is the largest of those values over the period.
| Point | Equity | Running peak | Drawdown from peak |
|---|---|---|---|
| Start | $10,000 | $10,000 | 0 |
| A | $12,500 | $12,500 | 0 |
| B | $9,800 | $12,500 | −$2,700 (−21.6%) |
| C | $13,000 | $13,000 | 0 |
| D | $11,700 | $13,000 | −$1,300 (−10.0%) |
| E | $14,000 | $14,000 | 0 |
The maximum drawdown here is 21.6%, from A to B: $2,700 ÷ $12,500. Note that B is below the starting balance, but the drawdown is measured from the peak at A, not from the start. Measured only against the initial deposit, the same drop would register as just $200.
The recovery asymmetry
Losses and gains are not symmetric. After a drawdown of d, the gain needed to get back to the previous peak is:
Required gain = d ÷ (1 − d)
From point B, equity of $9,800 needs to grow by $2,700, which is 27.6%, to regain $12,500. The formula gives the same answer: 0.216 ÷ 0.784 = 0.276.
| Drawdown | Gain needed to recover |
|---|---|
| 10% | 11.1% |
| 20% | 25.0% |
| 25% | 33.3% |
| 30% | 42.9% |
| 40% | 66.7% |
| 50% | 100.0% |
| 60% | 150.0% |
| 75% | 300.0% |
The curve is gentle at first and then steep. Below about 20%, recovery takes a little more than the loss. Past 50%, recovery requires doubling the remaining capital, and under fixed-fractional sizing the smaller account also means smaller position sizes on the way back. The drawdown recovery calculator shows the required gain and how many months recovery takes at a steady monthly return.
Drawdown duration
Depth is only half the picture. Drawdown duration is the time from a peak until equity exceeds that peak again. It splits into time falling and time recovering.
Suppose point A in the table was reached at the end of February, B at the end of May, and equity first exceeded $12,500 again in late August. The drawdown lasted about six months, three of them spent falling. A strategy with a modest maximum drawdown but long stretches underwater can be harder to stick with than one with sharper, shorter dips. Record both numbers.
Balance drawdown and equity drawdown
Drawdown measured on closed-trade balance ignores losses on positions that are still open. Drawdown measured on equity includes them. A strategy that holds losing trades and closes winners quickly can show a small balance drawdown and a much larger equity drawdown. MetaTrader 5 reports both, along with absolute, maximal and relative versions, and the differences are covered in the guide to the MT5 Strategy Tester report. When you set limits, use equity drawdown unless you have a specific reason not to.
Using drawdown to set limits
A drawdown limit works best when it is decided in advance and tied to position size. Two common structures:
- A reduction level. At a set drawdown, such as 10%, cut risk per trade, for example from 1% to 0.5%. This slows further losses while the strategy proves itself again.
- A stop level. At a deeper drawdown, such as 20%, stop trading the strategy and review it.
Translate each level into trades so the limit has meaning. At 1% risk per trade, 11 consecutive losses take equity below −10% (0.99^11 = 0.895). At 2% risk, six losses do it (0.98^6 = 0.886). If your historical worst losing streak is longer than the number of losses your limit allows, the limit will be hit by normal variation rather than by a broken strategy.
Prop-firm drawdown rules
Funded-trader programs commonly enforce two kinds of limit, and the details vary by firm:
- a daily loss limit, measured from the start-of-day balance or equity
- a maximum loss limit, either static or trailing
The difference between static and trailing matters. Take a hypothetical $100,000 account with a $10,000 maximum loss. Under a static rule, the floor stays at $90,000 whatever happens. Under a rule that trails the highest equity by $10,000, a run to $108,000 lifts the floor to $98,000. A pullback from the peak of only 9.3% then ends the account, even though it is still 2% below the starting balance.
Read whether each limit uses balance or equity, when the daily reset happens, and whether the trailing floor stops moving at some point. Then size positions so that a realistic bad day cannot breach the daily limit. If the daily limit is $5,000 and each trade risks $1,000, five losing trades in one session end the account, and floating losses on open trades count against an equity-based limit before any stop is hit.
Why the backtest drawdown is not the worst case
A backtest or live record shows one sequence of trades. Reshuffle the same trades into a different order and the maximum drawdown changes, often substantially. The historical figure is one sample from a distribution, and the next stretch of trading can easily produce a deeper one. Monte Carlo resampling of your trade history, as described in the risk of ruin guide, gives a range of plausible maximum drawdowns. Planning around a high percentile of that range is more realistic than planning around the single historical number. Trading carries a risk of loss beyond anything a backtest has shown.
Key points
- Maximum drawdown is the largest peak-to-trough decline in equity, measured from the running peak.
- Recovering from a drawdown d needs a gain of d ÷ (1 − d): 25% after a 20% loss, 100% after a 50% loss.
- Track drawdown duration as well as depth, and prefer equity drawdown over balance drawdown.
- Set reduction and stop levels in advance and check them against your normal losing streaks.
- For prop-firm accounts, know whether limits are static or trailing and measured on balance or equity.