Risk & Money ManagementMax DDPeak-to-Trough Decline
Maximum Drawdown
The largest peak-to-trough equity decline recorded over a given period of trading or testing.
What Maximum Drawdown means
Maximum drawdown is found by scanning an equity curve for every peak, measuring the deepest subsequent trough before a new peak is set, and keeping the worst result. It is usually quoted as a percentage and accompanied by two supporting figures: the duration of the decline and the time taken to recover the previous high. Together these describe the single worst experience the strategy delivered, which is often a more honest summary of tolerability than any average-based statistic.
The figure is the denominator of the Calmar ratio and a standard input to risk-of-ruin work, but it carries an obvious limitation: it is entirely backward-looking and depends on the sample examined. A longer track record almost always produces a larger maximum drawdown simply because it contains more opportunities for one, so comparing a two-year record against a ten-year one is misleading. Prudent practice is to assume the future worst case will exceed the historical one, often by a wide margin.
Worked example
A strategy whose equity peaked at 18,000 dollars and later bottomed at 12,600 dollars before recovering has a maximum drawdown of 5,400 dollars, or 30 percent of the peak.
Related terms
- DrawdownThe decline from a peak in account equity to a subsequent trough, usually stated as a percentage of the peak.
- Calmar RatioAnnualised return divided by maximum drawdown over the same window, conventionally measured across three years.
- BacktestingReplaying a strategy's rules over historical price data to estimate how it would have performed before risking real money.
- Risk of RuinThe probability that an account will lose a defined portion of its capital before reaching a chosen profit objective.
- EquityThe live value of a trading account: balance plus the floating profit or loss of every open position.
Frequently asked questions
What does Maximum Drawdown mean in forex trading?
The largest peak-to-trough equity decline recorded over a given period of trading or testing.
How does Maximum Drawdown work in practice?
The figure is the denominator of the Calmar ratio and a standard input to risk-of-ruin work, but it carries an obvious limitation: it is entirely backward-looking and depends on the sample examined. A longer track record almost always produces a larger maximum drawdown simply because it contains more opportunities for one, so comparing a two-year record against a ten-year one is misleading. Prudent practice is to assume the future worst case will exceed the historical one, often by a wide margin.
What is an example of Maximum Drawdown?
A strategy whose equity peaked at 18,000 dollars and later bottomed at 12,600 dollars before recovering has a maximum drawdown of 5,400 dollars, or 30 percent of the peak.
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