What Is Drawdown? Definition & Example

Drawdown measures the fall from a peak to the subsequent low, expressed as a percentage. Maximum drawdown — the largest such fall over a period — is the standard measure of how painful a strategy has been to hold, and it is a far better risk metric than volatility for anyone trading their own capital.

The reason it matters more than most people expect is that recovery is not symmetrical. Losing 20% requires a 25% gain to get back. Losing 50% requires 100%. Losing 80% requires 400%. Each additional unit of loss demands disproportionately more to undo, which is why capital preservation compounds more reliably than aggressive returns.

This asymmetry is the mathematical case for conservative position sizing. Risking 1% per trade means twenty consecutive losses leave you with 82% of your account — recoverable, and psychologically survivable. Risking 10% leaves you with 12%, needing a 722% gain to return to break-even. The strategy did not need to be wrong for this to happen; it only needed a normal losing streak.

Drawdown is also the honest measure of whether you can actually run a strategy. A backtest showing 200% annual returns with a 70% maximum drawdown is not a strategy most people can execute, because almost nobody keeps sizing consistently through a 70% decline. The returns are real only if you stay in the seat.

When evaluating any track record — your own or someone else's on a leaderboard — look at maximum drawdown before looking at returns. It tells you what the returns cost.