Maximum Loss and Drawdowns

Measuring

Track the account's highest equity. Drawdown at any moment is the current equity's shortfall from that peak, as a percentage of the peak. If the peak was 12,000 and equity is 10,200, the drawdown is 15 percent. The maximum drawdown is the deepest trough recorded, and it is what prop firms limit and what fund investors ask about first.

The recovery asymmetry

Gain to recover equals loss divided by one minus loss. A 50 percent loss needs a 100 percent gain, which takes a long time at a sensible risk per trade. This arithmetic is why risk per trade is kept small: it keeps drawdowns in the range where recovery is a matter of weeks rather than years. The drawdown recovery calculator does the sum.

A maximum loss limit

Decide in advance the drawdown at which you stop trading live and go back to the demo, perhaps 15 or 20 percent for a beginner. Write it down. Prop firms enforce theirs at 8 to 12 percent; a self-funded trader without a limit tends to discover theirs at 60 percent. The limit is not an admission of failure; it is the point at which the cost of continuing exceeds the cost of stopping to find out what went wrong.

Drawdown and psychology

Most bad decisions are made in drawdowns: increasing size to recover, abandoning the strategy, trading more often. A limit that is agreed in advance, when you are calm, removes the decision from the moment when you are not.

Key takeaways

• Drawdown is the decline from peak, as a percentage of the peak.
• Recovery requires a larger percentage than the loss, and the gap grows fast.
• Set a maximum loss at which you stop and review.
• Decide it in advance, because you will not decide it well in the moment.