Drawdown measures how much a trading account has fallen from its peak value before recovering. If your account grows to $40,000 and then falls to $32,000, you are in a 20% drawdown — not measured from your starting balance, but from the most recent high.
Types of Drawdown
Absolute drawdown: The difference between the starting balance and the lowest point the account ever reached. Measures the worst loss from inception.
Maximum (relative) drawdown: The largest peak-to-trough decline at any point in the account's history, expressed as a percentage. This is the standard metric used by professional traders, fund managers, and prop firms.
The Formula
Max Drawdown = (Peak − Trough) ÷ Peak × 100
Example: account peaked at $25,000, bottomed at $18,500 before recovering. DD = ($25,000 − $18,500) ÷ $25,000 = 26%.
Why Recovery Math Matters
Recovering from a drawdown requires proportionally more than what was lost:
- Lose 10% → need 11.1% to recover
- Lose 25% → need 33.3% to recover
- Lose 50% → need 100% to recover
- Lose 60% → need 150% to recover
This asymmetry is why limiting drawdown through position sizing is more important than maximizing returns. A drawdown that seems manageable (say, 30%) already requires a 42.9% gain just to get back to breakeven — before making any new profit.