Drawdown
Definition
A drawdown is the peak-to-trough decline in account equity — it measures how far you've fallen from your high-water mark, either from a single losing trade or a series of losing trades.
Example
“I hit a new account high of $28,400 in early March, then a rough two weeks brought me to $24,200. That $4,200 decline was my drawdown — about 14.8% — and it forced me to review everything.”
Detailed Explanation
Drawdown is one of the most psychologically difficult aspects of trading to manage. Losing streaks and drawdowns are mathematically inevitable in any strategy — even a 60% win rate strategy will have periods of consecutive losses. The danger isn't the drawdown itself; it's the typical response to it. Traders in drawdown often increase size to "make it back faster," start deviating from their rules, or completely abandon a good strategy that's temporarily underperforming. All three responses usually make the drawdown worse.
The mathematics of recovery make drawdowns asymmetric and punishing. A 20% drawdown requires a 25% gain to return to breakeven. A 40% drawdown requires a 67% gain. A 50% drawdown requires a 100% gain. This is why professional traders are almost paranoid about drawdown control — protecting capital on the downside is not just about comfort, it's about the mathematics of survival. Cutting your losses small means you're never trapped needing an outsized return just to break even.
A healthy response to drawdown is to reduce position size by 25–50% until you return to breakeven. This accomplishes two things: it slows the rate of equity decline if the rough patch continues, and it forces you to trade with precision rather than size — which often reveals whether the drawdown was from bad luck or bad decisions. If your win rate recovers at smaller size, the system is intact and variance was the issue. If the losses continue at smaller size, something in your strategy needs diagnosing.