What is maximum drawdown?

A drawdown is any decline from a running peak. Each time the account makes a new high, the peak resets, and the next fall is measured from there. The maximum drawdown is the deepest of these declines over the whole period you look at.

The drawing at the top of the page shows why it is measured from the peak, not from the starting balance. The account starts at $10,000, rises to $12,500 and falls to $9,500. From the start, that looks like a 5% loss; from the peak, it is a 24% drawdown, and $3,000 of gains have been given back. The earlier dip from $11,000 to $10,450 was also a drawdown, of 5%, but not the maximum.

Drawdown
The decline of an account or equity curve from its most recent peak, usually in percent: (current value − peak) ÷ peak.
Maximum drawdown (MDD)
The largest peak-to-trough decline over a period, before a new peak. It describes the worst loss someone following the method from a peak would have lived through.
High-water mark
The highest value the account has reached so far: the running peak that every drawdown is measured from.
Drawdown duration
The time from a peak to the moment the account first gets back above it, also called time under water.

How to calculate maximum drawdown step by step

You need the account value at regular points, after each trade, day or month. Hypothetical month-end values: $10,000, $10,600, $10,300, $11,000, $10,200, $9,900, $10,900 and $11,400. In a spreadsheet, it takes two extra columns:

  1. List the account value at each point, including open positions, and remove deposits and withdrawals so they do not hide or create drawdowns.
  2. Track the running peak, the highest value so far: 10,000, 10,600, 10,600, 11,000, 11,000, 11,000, 11,000 and 11,400.
  3. Compute the drawdown at each point as (value − peak) ÷ peak: 0, 0, −2.8%, 0, −7.3%, −10.0%, −0.9% and 0.
  4. The maximum drawdown is the most negative value: −10.0%, from the $11,000 peak to the $9,900 trough.
  5. Note the dates of the peak, the trough and the next new high, so you also know how long the drawdown lasted.

The recovery math: why a 50% loss needs a 100% gain

After a drawdown of d, the gain needed to get back to the peak is 1 ÷ (1 − d) − 1, because the gain is earned on a smaller balance. A 10% drawdown needs +11.1%, a 20% drawdown +25%, a 30% drawdown +42.9%, a 50% drawdown +100% and a 75% drawdown +300%. In the example at the top, $9,500 needs $3,000 more to reach $12,500, a gain of 31.6%.

Time makes it worse. At a hypothetical 2% a month, compounded, recovering from a 24% drawdown takes about 14 months; recovering from a 50% drawdown takes about 35 months. Shallow drawdowns heal quickly, deep ones can take years, which is why compound interest works against you when you lose and why the risk management lesson puts drawdown rules in every plan.

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A curve of the gain needed to get back to the peak against the drawdown, under the formula gain needed = 1 ÷ (1 − drawdown) − 1. Marked points: −10% → +11.1%, −24% → +31.6%, −50% → +100% and −75% → +300%. A dotted grey line shows what it would look like if the gain needed equaled the loss; the curve bends away above it faster and faster.

How risk per trade drives drawdowns

Most drawdowns come from losing streaks, and every method has them, even one with a positive expectancy. Over hundreds of trades, a setup that loses more often than it wins can easily see 8 or 10 losses in a row. What that streak costs depends almost entirely on the risk per trade.

With a fixed share r of current equity at risk, 10 straight losses leave (1 − r)^10 of the account. At 1% per trade, that is 0.99^10 ≈ 90.4%, a drawdown of about 9.6% that needs +10.6% to recover. At 2%, about 18.3%. At 5%, 0.95^10 ≈ 59.9%, a drawdown of about 40.1% that needs about +67% to recover. At 10%, about 65.1%. The drawdown grows much faster than the risk.

This is why sizing from the stop with the position size calculator matters more than any entry rule, and why the Kelly criterion lesson recommends a small fixed fraction instead of the full Kelly bet. Risking a fixed dollar amount instead, 2% of the starting balance on every trade, would make 10 losses cost exactly 20%, more than the 18.3% of the shrinking-size method.

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Four lines start at 100 and fall over 10 losses in a row, with the risk a share of current equity: 1% ends at 90.4 (−9.6%), 2% at 81.7 (−18.3%), 5% at 59.9 (−40.1%) and 10% at 34.9 (−65.1%). The gap between the lines widens with every loss.

Drawdown duration and the Calmar ratio

Depth is half the story. Drawdown duration is the time from a peak to the next new high: in the example at the top, 8 months. A shallow drawdown that lasts two years can test discipline as much as a deep one that recovers in weeks, and long flat periods are when many traders abandon a method or start breaking its rules, as trading psychology explains.

The Calmar ratio puts return and drawdown together: annual return ÷ maximum drawdown, usually measured over the last 36 months. Hypothetical: strategy A returns 12% a year with a 30% maximum drawdown, a Calmar of 0.40; strategy B returns 8% a year with a 10% maximum drawdown, a Calmar of 0.80. B earns less, but twice as much per point of drawdown, and at the same drawdown budget it could be sized up.

Treat any drawdown from a backtest as a floor, not a ceiling. The worst drawdown of a test is only the worst one that happened in that sample; live trading adds costs, slippage and changing markets, and an optimized test usually understates it, as explained in backtest overfitting.

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Two cards under the title Calmar ratio = annual return ÷ maximum drawdown. Strategy A: a steep equity curve with a deep dip, 12% a year, max drawdown 30%, and 12 ÷ 30 = 0.40. Strategy B: a smoother curve, 8% a year, max drawdown 10%, and 8 ÷ 10 = 0.80, highlighted. Notes: more return per point of drawdown, and hypothetical figures, not results.

How to set a maximum drawdown limit

Decide the deepest drawdown you could sit through without breaking your rules, then work backward to the size of each trade. Write the numbers into your trading plan before the drawdown starts, because during one, every decision feels urgent. A common framework, with hypothetical numbers:

  • Set a personal limit, for example a 20% drawdown from the high-water mark at which you stop trading and review everything.
  • Size so a normal losing streak stays far from it: at 1% risk, 10 straight losses cost about 9.6%.
  • Step down: cut the risk per trade in half after a 10% fall from the peak, and pause to review after 15%.
  • Add daily and weekly loss limits so one bad session cannot do most of the damage.
  • Count correlated positions as one bet: three tech stocks stopped out on the same day act like one larger loss.
  • Return to full size only under a rule you wrote in advance, such as after recovering half of the drawdown.

Common maximum drawdown mistakes

The calculation is simple; these habits make the number misleading:

  • Measuring from the starting balance instead of the running peak, which hides drawdowns after a run of gains.
  • Counting only closed trades, so open positions that swing deep before closing never show up.
  • Letting deposits mask a drawdown: adding $2,000 to a falling account is not a recovery. Track returns, not just the balance, in your trading journal.
  • Assuming the backtest’s worst drawdown is the worst that can happen.
  • Raising size to win it back faster, which turns a drawdown into a deeper one.
  • Watching only the depth and ignoring how long the account has been under water.