Drawdown and recovery: why a 50% loss needs a 100% gain

A drawdown is the fall in an account from its peak to its lowest point before a new peak. It decides whether a trader survives long enough for an edge to show, and it behaves in a way many people underestimate.

Losses need bigger gains to recover

After a loss, the gain needed to get back to the peak is the loss divided by one minus the loss:

• a 10% drawdown needs an 11.1% gain
• 20% needs 25%
• 30% needs 42.9%
• 50% needs 100%
• 75% needs 300%
• 90% needs 900%

Small drawdowns are easy to recover from. Beyond about 30%, the required gain climbs quickly, and traders under pressure to get back to even often raise their risk, which makes the next loss bigger.

Losing streaks at different risk levels

Every method has losing streaks. Here is what ten losses in a row do to an account when each trade risks a fixed percentage of the current balance:

• 1% per trade: the account falls about 9.6%
• 2% per trade: about 18.3%
• 5% per trade: about 40.1%
• 10% per trade: about 65.1%

Ten straight losses sound rare, but not for a method that wins 40% of the time. The chance that any particular ten trades all lose is about 0.6%, and across the hundreds of trades an active trader places in a year, a streak that long becomes likely. Risk per trade decides whether that streak is a setback or the end of the account. To turn a percentage into a lot size, see position sizing.

Rules that keep drawdowns manageable

• Fix risk per trade as a percentage of the account, and don't raise it to win back losses.
• Set a daily or weekly loss limit, such as three losing trades or 3% in a day, after which you stop.
• Reduce size in a drawdown. Some traders halve their risk after a 10% drawdown and restore it at a new account high.
• Know your method's normal drawdown from your journal or a backtest, so you can tell an ordinary losing run from a method that has stopped working.

Leverage and drawdowns

High leverage doesn't change the maths above, but it makes large losses possible in a single trade, and a margin close-out can lock in a loss before a planned stop is reached. Prop firm evaluations are built around drawdown rules for the same reason: breach the maximum drawdown and the account is gone. The behavioural side of losing runs is covered in revenge trading and overtrading.