Drawdown and the maths of recovery: why losing 50% is far worse than it sounds

Drawdown is the distance between your account's highest point and where it is now, as a percentage. If your account peaked at 10,000 and now sits at 8,500, you're in a 15% drawdown. It's the most honest measure of how much a system hurts: the final profit doesn't tell you what you went through to get it, but the drawdown does.

The recovery trap

Here's the counter-intuitive bit. Losing 50% and then gaining 50% doesn't put you back where you started: from 100 you drop to 50, and 50% of 50 is only 25, so you're at 75. To get back to 100 you need to gain 100%. As a formula: to recover a loss of L% you need a gain of L ÷ (100 − L).

Up to about 20% the climb back is reasonable. Beyond 40-50% it becomes a mountain: you have to make in a few months what took you a long time to lose, with a smaller account and a clouded head. That's why the first rule of risk management isn't "make money". It's "don't dig a hole you can't get out of."

An equity curve, trade by trade

Take twelve trades risking 1% on a 10,000 account. The results in R-multiples: +2, −1, −1, +2, −1, −1, −1, +3, −1, −1, +2, −1. There are 4 winners out of 12, just a third, and yet the total is +9R −8R = +1R.

The maximum drawdown is 3%. At 5% risk per trade, the exact same sequence would have produced a maximum drawdown of about 15%. Same results, different size. Risk per trade is the dial that sets how much pain you're willing to live with.

Types of drawdown

• Maximum drawdown: the worst in the history of the account or system. It's the number to know before you start.
• Current drawdown: how far below the peak you are right now.
• Duration: how long you spend below the peak. A long drawdown is often more wearing than a deep one.

When you look at a backtest or a trader's stats, always ask for the maximum drawdown and how long it lasted. A system that promises big returns without showing its drawdown is hiding half the picture.

Drawdowns are expected, not a failure

Even a system with a positive statistical edge goes through bad stretches, sometimes long ones. If your strategy has historically had a 10% maximum drawdown at 1% risk, it's normal to meet one like it live, and sooner or later one worse than the historical one. The right question isn't "how do I avoid it?" but "can my plan survive it, in money and in my head?"

Limits to write into your plan

A limit written in advance beats a thousand good intentions in the middle of a storm. An example ladder, to adapt:

• −5% from peak: halve your risk per trade until you're back above −3%.
• −10%: stop trading for a few days and do a full review of your journal.
• −15/−20%: a long break, back to demo or minimum risk until you work out whether the problem is the system or your behaviour.

These aren't numbers to copy. They're a way of deciding today, clear-headed, what you'll do tomorrow when you're in trouble.

In short

• Drawdown is the distance from your account's peak: it measures how much you really suffer.
• Recovery is asymmetric: −50% needs +100%.
• For the same sequence of results, a higher risk per trade produces a much deeper drawdown.
• Write your risk-reduction and stop-trading limits down in advance.

Practice

1. Take your last 20 results (or invent them) and build the equity curve at 1% risk, then at 3%. Compare the two maximum drawdowns.
2. Work out what you'd need to recover losses of 15%, 35% and 55%.
3. Write your ladder of limits (−5%, −10%, −20%), with the concrete action for each.