How to Calculate Your Maximum Drawdown
Maximum drawdown is the largest peak-to-trough decline in your account before a new high is reached. It is the single best measure of how much pain a strategy (or a trader) has experienced. If you do not track it, you are flying blind.
What Is Drawdown?
Drawdown measures the decline from a peak in your account equity to its subsequent low point. It is expressed as a percentage.
Drawdown = (Peak Value - Trough Value) / Peak Value x 100
If your account grows from $10,000 to $15,000 and then drops to $12,000, the drawdown from that peak is:
($15,000 - $12,000) / $15,000 = 20%
Maximum drawdown is the largest such decline over the entire history of your account or strategy. It represents the worst-case scenario that actually happened.
A Worked Example
Suppose your account goes through this sequence of monthly values:
| Month | Account Value | Peak | Drawdown |
|---|---|---|---|
| Jan | $50,000 | $50,000 | 0% |
| Feb | $55,000 | $55,000 | 0% |
| Mar | $48,000 | $55,000 | -12.7% |
| Apr | $44,000 | $55,000 | -20.0% |
| May | $52,000 | $55,000 | -5.5% |
| Jun | $58,000 | $58,000 | 0% |
The maximum drawdown was -20.0%, occurring from the February peak of $55,000 to the April trough of $44,000. Even though the account eventually recovered and hit a new high in June, that 20% drawdown is permanently recorded as part of the strategy's history.
Track your own drawdown with the Drawdown Calculator.
The Recovery Math Problem
This is the part that catches most traders off guard. A loss and a gain of the same percentage are not equal. If you lose 50%, you need a 100% gain just to get back to where you started. The math gets worse as the drawdown increases.
| Drawdown | Gain Needed to Recover | At 10% Annual Return |
|---|---|---|
| 5% | 5.3% | ~6 months |
| 10% | 11.1% | ~1.1 years |
| 15% | 17.6% | ~1.7 years |
| 20% | 25.0% | ~2.3 years |
| 30% | 42.9% | ~3.7 years |
| 40% | 66.7% | ~5.4 years |
| 50% | 100.0% | ~7.3 years |
| 75% | 300.0% | ~15+ years |
This table is the strongest argument for keeping drawdowns small. A 20% drawdown is recoverable in a reasonable time. A 50% drawdown might take the better part of a decade. And a 75% drawdown is effectively a blown account for most retail traders.
Typical Drawdowns by Strategy Type
Not all strategies are created equal. Understanding what level of drawdown is normal for your approach helps you set realistic expectations:
| Strategy Type | Typical Max Drawdown |
|---|---|
| Buy-and-hold (S&P 500) | 30-55% |
| Swing trading (disciplined) | 10-25% |
| Day trading (experienced) | 5-15% |
| Trend following | 20-40% |
| Market-neutral / hedged | 5-15% |
If your strategy's drawdown far exceeds these ranges, something is likely wrong with your risk management, not your stock selection.
How to Limit Your Drawdown
1. Use Proper Position Sizing
The most effective drawdown control is limiting how much you risk per trade. With the 1-2% rule, even a losing streak of 10 trades only costs 10-20% of your account. Without position sizing, a single bad trade can cause a 20% drawdown on its own.
2. Limit Correlated Positions
Five tech stocks are not five independent positions. If the tech sector drops, all five lose money simultaneously. Cap your exposure to any single sector at 2-3 positions, or reduce position sizes when holding correlated names.
3. Set a Daily or Weekly Loss Limit
Decide in advance that you will stop trading for the day if you lose more than 2-3% of your account, or for the week if you lose more than 5%. This circuit breaker prevents emotional revenge trading from turning a bad day into a catastrophic one.
4. Reduce Size During Losing Streaks
If you are in a drawdown, cut your position sizes in half until you start winning again. This slows the bleeding and protects your capital for when conditions improve. Scale back up gradually as you recover.
5. Track Your Drawdown in Real Time
Know your current drawdown at all times. If you peaked at $60,000 and your account is now at $54,000, you are in a 10% drawdown. This awareness helps you make rational decisions about whether to continue trading or take a break.
The Psychological Impact
Drawdowns are not just a math problem. They are a psychological one. Research shows that the pain of losing money is roughly twice as intense as the pleasure of gaining the same amount. A 20% drawdown does not just cost you money. It costs you confidence, sleep, and decision-making clarity.
This is why the best traders are obsessed with limiting drawdowns rather than maximizing returns. A strategy that returns 15% per year with a 10% maximum drawdown is far better than one that returns 25% per year with a 40% maximum drawdown. The Compound Interest Calculator confirms what steady, low-drawdown growth does over time.
The Bottom Line
Track your maximum drawdown. Know the recovery math. Use position sizing and loss limits to keep it under control. The traders who survive long enough to become profitable are the ones who never let a drawdown get out of hand.
Calculate your drawdown now with the Drawdown Calculator.