Risk & Money ManagementEquity Drawdown
Drawdown
The decline from a peak in account equity to a subsequent trough, usually stated as a percentage of the peak.
What Drawdown means
Drawdown measures how far an account has fallen from its own high-water mark before making a new high. It is calculated as peak equity minus trough equity, divided by peak equity, and it is normally tracked on the equity curve so that open floating losses are included rather than hidden. Reporting conventions vary: absolute drawdown measures the fall below the initial deposit, relative drawdown expresses the largest fall as a percentage, and maximum drawdown records the worst such episode across the whole record.
Drawdown matters more than most traders expect because recovery is mathematically asymmetric. A 20 percent decline requires a 25 percent gain to get back to level, a 33 percent decline requires 50 percent, and a 50 percent decline requires a full 100 percent. Depth is only half the story, since a shallow drawdown that lasts eighteen months can be harder to sit through than a sharp one that recovers in a fortnight. Sizing rules exist chiefly to keep this figure survivable.
Worked example
An account that peaks at 12,500 dollars and falls to 10,000 dollars has suffered a 2,500 dollar drawdown, or 20 percent, and must now make 25 percent on the reduced balance just to return to its previous high.
Related terms
- Maximum DrawdownThe largest peak-to-trough equity decline recorded over a given period of trading or testing.
- EquityThe live value of a trading account: balance plus the floating profit or loss of every open position.
- Risk of RuinThe probability that an account will lose a defined portion of its capital before reaching a chosen profit objective.
- Calmar RatioAnnualised return divided by maximum drawdown over the same window, conventionally measured across three years.
- Money ManagementThe set of rules governing how much capital is risked per trade, per day and across all open positions.
Frequently asked questions
What does Drawdown mean in forex trading?
The decline from a peak in account equity to a subsequent trough, usually stated as a percentage of the peak.
How does Drawdown work in practice?
Drawdown matters more than most traders expect because recovery is mathematically asymmetric. A 20 percent decline requires a 25 percent gain to get back to level, a 33 percent decline requires 50 percent, and a 50 percent decline requires a full 100 percent. Depth is only half the story, since a shallow drawdown that lasts eighteen months can be harder to sit through than a sharp one that recovers in a fortnight. Sizing rules exist chiefly to keep this figure survivable.
What is an example of Drawdown?
An account that peaks at 12,500 dollars and falls to 10,000 dollars has suffered a 2,500 dollar drawdown, or 20 percent, and must now make 25 percent on the reduced balance just to return to its previous high.
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