What is max drawdown in trading?
In one line: Max drawdown is the largest drop from a peak to a later low in an account or a set of trades, before a new peak is reached. It's often shown as a percent.
The idea
Every account goes up and down. A Drawdown is any dip from a high point.
Max drawdown is the deepest one. It's the worst stretch you had to sit through.
A simple example
Here's a running total of practice trades, in units of risk (R):
0 → +5 → +8 → +4 → +2 → +7 → +12 → +9 → +14
Find each dip from a high:
- From +8 down to +2: a 6R drop.
- From +12 down to +9: a 3R drop.
The max drawdown is 6R. A math example, not a promise.
In percent: say an account goes from 10,000 up to 12,000, then down to 9,000. The drop is 3,000 from the 12,000 high, so 3,000 ÷ 12,000 = 25%. Measure from the peak, not from where you started.
Why it matters
Max drawdown is the number that tests your nerve.
- It tells you how deep a bad stretch has been, so you can ask if you'd stick with it.
- Bigger drops need even bigger gains to recover. A 25% drop needs 33.3% back. See compounding losses and the loss recovery calculator.
- Prop firms and many traders set hard limits based on it.
A common mistake
Thinking your past max drawdown is the worst that can happen. It's only the worst so far, in the one order your trades happened to come in. A different order could be deeper. A Monte Carlo simulation reshuffles your trades to show that range.
A handy plan: expect a future drawdown about 1.5 to 2 times your worst tested one. If that would make you quit, lower your risk per trade now.
To see how well a method climbs back from its drops, see recovery factor.
Questions
How do you calculate max drawdown?
Track your running balance. For each new high, note the lowest point before the next high. The biggest of those drops is your max drawdown.
What is a good max drawdown?
There's no single number. It should be small enough that you'd keep following your rules through it. Lower risk per trade makes it smaller.
Is max drawdown measured from the starting balance?
No. It's measured from the highest point reached before the drop, wherever that was.
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