What is Drawdown?
The peak-to-trough decline in equity — the psychological cost of every strategy.
Definition
Drawdown = (peak_equity − current_equity) ÷ peak_equity. Reported in two flavours: *current* drawdown (right now, vs latest peak) and *max drawdown* (the worst peak-to-trough across the whole sample). Recovery time is equally critical: a 25% drawdown that takes 3 months to recover is operationally different from one that takes 18 months.
Why it matters for trading
- Drawdown is the constraint that decides whether you stay in the strategy. Most strategies are abandoned not because they stopped working but because the drawdown exceeded what the operator could psychologically hold.
- Drawdown ≠ volatility. A strategy with 20% vol can have a 50% drawdown if the bad days cluster. Path-dependence matters, not just dispersion.
- Drawdown / Sharpe / hit-rate are joint constraints. Sizing should be calibrated so that *expected* max drawdown (forward-looking) sits well inside the operator's pain threshold — typically 1.5-2× the historical max.