Drawdown
Also known as: Max Drawdown, DD
The peak-to-trough decline of an account balance, expressed as a percentage or monetary value.
Plain-English Meaning
Drawdown measures how much your account has dropped from its highest point. If you build your account up to $10,000, and a series of losing trades drops it to $8,000, your account has experienced a 20% drawdown.
Why It Matters
Drawdown is the ultimate measure of a trading system's risk and volatility. Recovering from deep drawdowns requires exponentially higher returns; an account that suffers a 50% drawdown needs a 100% gain just to get back to where it started.
Simple Example
A trader starts with $5,000, grows it to $6,000 (peak), then loses $1,200 on a bad trade, bringing the balance down to $4,800 (trough). The drawdown is calculated from the $6,000 peak, resulting in a 20% drawdown.
This educational example uses selected assumptions for reference calculation purposes. Real conditions may vary by broker, exchange, or instrument.
Beginner Mistake
Ignoring maximum drawdown limits when testing a strategy. Focusing entirely on the final profit number without realizing the strategy required enduring an agonizing 60% drawdown along the way.