What is drawdown in trading? Max drawdown explained simply

What drawdown means

Drawdown is how far an account, or a strategy, falls from its highest point before it recovers. It is written as a percentage of that high.

If an account grows from $10,000 to $12,000 and then falls to $9,600, the drawdown is 20%: the account is $2,400 below its $12,000 high, and $2,400 is 20% of $12,000. Note that the account is still only 4% below where it started. Drawdown measures the fall from the peak, not from the start.

Max drawdown is the largest drawdown over a period. It is the single number that best describes how painful a strategy was to hold.

Why drawdown matters as much as the result

Two strategies can end a year at the same place and feel completely different along the way. One rises steadily. The other falls 40%, then recovers. On paper they are equal. In practice, most people would abandon the second one near the bottom, locking in the 40% loss.

Drawdown tells you three things the final result hides:

• How much pain you would have to sit through, and whether you realistically would.
• How much risk the strategy took to get its result. A small gain with a huge drawdown is a poor trade-off.
• How long recovery might take. Deeper falls need disproportionately larger gains to recover.

How to calculate drawdown

1. Record the account value at regular points, such as daily.
2. Keep a running high: the highest value reached so far.
3. At each point, compute (running high minus current value) divided by running high.
4. The largest result over the period is the max drawdown.

A short example with daily values of $10,000, $10,500, $10,200, $9,450, $9,900 and $11,000:

• The running high reaches $10,500 on day 2.
• On day 4 the account is at $9,450: ($10,500 minus $9,450) divided by $10,500 is 10%.
• On day 6 the account makes a new high of $11,000, ending the drawdown.
• The max drawdown over the six days is 10%.

The recovery problem

Losses and gains are not symmetric. The deeper the fall, the larger the gain needed to get back:

• After a 10% drawdown, the account must rise 11% to get back.
• After a 20% drawdown, the account must rise 25% to get back.
• After a 33% drawdown, the account must rise 50% to get back.
• After a 50% drawdown, the account must rise 100% to get back.
• After a 75% drawdown, the account must rise 300% to get back.

This is why limiting drawdown is often more important than chasing a slightly higher result. Avoiding a deep fall saves you the climb back.

Drawdown in crypto

Crypto prices swing far more than most traditional markets. Holding a major coin has historically meant living through deep drawdowns, sometimes well over half the value, during bear markets. A strategy that merely matches holding inherits those falls.

That is why the useful comparison for any crypto strategy is not just "did it end higher than holding?" but "how deep was its worst drop compared with holding?" A strategy that ends slightly behind holding with half the drawdown may be the better one to actually live with.

Drawdown versus volatility

Volatility measures how much a price swings in both directions. Drawdown measures only the falls from a high, and how deep they get. A coin can be very volatile but recover quickly, with shallow drawdowns, or move slowly but grind down for months into a deep one. For deciding whether you could live with a strategy, drawdown is usually the more useful number, because it describes the losses you would actually sit through.

How to limit drawdown

• A stop-loss on every position, so one trade cannot fall without limit. See what is a stop-loss.
• A cap on how much is invested at once, such as at most 2 open buys per strategy.
• A daily loss limit, which stops trading for the day after a set amount is lost.
• Small position sizes, so that even several losses in a row keep the account well above its high.
• No leverage. Leverage multiplies drawdown as well as gains.
• No unlimited averaging down, which turns a falling market into an ever-larger position.

A worked example

The illustrative BTC Dip Buyer backtest over 90 days shows the strategy ending 6.8% higher after fees, with a worst drop of 4.9%. Holding BTC over the same 90 days ends 3.1% higher, with a worst drop of 10.7%.

Read together: the rules gave a smaller worst drop than holding in this one period, largely because the stop-loss and the 2-buy limit kept the strategy out of the deepest part of the fall. A different period could tell a different story, which is why you would test several. This is an illustrative example, not a real result.

How TradeCorgi uses drawdown

• Every backtest shows the worst drop at the same size as the result, next to the worst drop from holding the coin.
• Every agent has a daily loss limit and pauses when it is reached, with the reason written down.
• No leverage and no averaging down beyond 2 entries, on every plan.
• On Pro, a portfolio limit caps combined losses across all your agents.

A drawdown checklist

• You know the max drawdown of the strategy in its backtest, and the period it covers.
• You have compared it with the max drawdown of holding the coin.
• You could sit through that drawdown with real money without switching the strategy off.
• Stops, a cap on open positions and a daily loss limit are all set.