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Max drawdown

The largest peak-to-trough decline an account or strategy has experienced over a period.

An equity curve and its drawdownAn account balance rising over a year, falling from a peak to a trough, then climbing back to the old peak.ACCOUNT EQUITY$20k$12k$8k024681012TIME (MONTHS)PEAK $16,000TROUGH $12,000DRAWDOWN−25%RECOVERY
Equity curve and drawdown. An account balance plotted month by month. The fall from the $16,000 peak to the $12,000 trough is a 25% drawdown, and the shaded area lasts until the balance climbs back to the old peak.

Max drawdown is the worst thing that has happened so far, which means the future max drawdown is probably larger. It is the number that tells you whether you could have psychologically and financially survived a strategy.

In backtesting, max drawdown is more important than total return, because a return you cannot sit through is a return you will not get.

Example: over three years a strategy returned 60% total but had a 28% drawdown lasting 11 months. A trader who would quit at -20% would have quit before the recovery.

Related: drawdown, backtesting, risk-of-ruin, trailing-drawdown

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