What Is Drawdown?
Drawdown measures the decline from a portfolio's peak value to its lowest point before recovering to a new peak. Maximum drawdown is the largest such decline ever recorded for a strategy or portfolio. A strategy with a 30% max drawdown means that at its worst, it lost 30% from its highest point before eventually recovering.
How Drawdown Works
Drawdown is expressed as a percentage and is one of the most important risk metrics because it directly measures pain. A 50% drawdown requires a 100% gain to recover. A 75% drawdown requires a 300% gain. The math is asymmetric and punishing. Professional funds typically target max drawdowns of 10-20%, while many retail crypto traders experience 50%+ drawdowns.
Why It Matters for Traders
Understanding your strategy's expected drawdown is essential for both risk management and psychology. If your backtest shows a 25% max drawdown, expect to encounter at least that much in live trading (often more). Setting a maximum acceptable drawdown before trading and having a plan to reduce position sizes or pause trading during deep drawdowns preserves capital and mental health.