Maximum Drawdown
The largest peak-to-trough decline an account or strategy has ever experienced.
Also called: max dd · peak to trough
Written by Javier Sánchez Ros
In plain language
Maximum drawdown is the worst single stretch in a track record. It answers the question that actually matters: what is the most pain this approach has ever delivered?
It is a far better description of risk than volatility, because it is the number that decides whether a trader abandons a strategy at the worst possible moment.
The historical maximum is a floor, not a ceiling. The worst drawdown a strategy has seen is simply the worst one so far.
Worked through
A backtest showing a 22% maximum drawdown
The number is real: across the tested period, the worst peak-to-trough fall the strategy suffered was 22%. It is tempting to read that as a boundary — this system loses about a fifth at its worst — and to size the live account accordingly.
But 22% is not a limit the strategy obeys. It is the deepest hole it happened to fall into across the particular stretch of history that was tested, in the particular order those trades arrived. Reshuffle the same trades into a different sequence and the maximum drawdown changes, sometimes considerably, without a single trade being different.
Run the live account at a size where 22% is survivable and you have prepared for the worst thing that has already happened. The useful question is the other one: what happens at 35%, at 45%? If the honest answer is "I would stop trading" or "I could not fund my life", the position size is wrong regardless of what the backtest says.
Every strategy that has ever blown up had, on the day before, a maximum drawdown that had never been exceeded.
Why it matters
Sizing decisions should be made against a drawdown larger than any you have experienced, because eventually you will experience one.
Common mistakes
- Treating a backtest’s maximum drawdown as a hard limit on future losses.
- Choosing a strategy on returns alone without asking what the ride looked like.
Keep exploring
These concepts are connected. Understanding one usually makes the next one easier.
The decline from an account’s peak value to its lowest point before a new peak.
The probability that a series of losses reduces an account below the point of recovery.
The set of rules that decides how much you can lose, before you think about what you can win.
The average amount you expect to win or lose per trade over a large sample.
The amount of an asset you buy or sell in a single trade.