What is drawdown in trading?

Written by: Gwyneth Lim | Copywriter

Drawdown refers to the decline in your trading account from its peak value to its lowest point before it recovers. It's typically expressed as a percentage and it stands as a key measure of risk and volatility, though the two aren’t quite the same thing (more on that later on).  

Tracking drawdown can help you understand your account or strategy has performed during periods of decline, rather than focusing solely on overall performance. Significant or prolonged drawdowns may indicate increased risk or volatility. Monitoring drawdown can help you assess whether your approach remains aligned with your objectives, risk tolerance, and broader risk management framework.  

A simple loss happens when a single trade closes with a negative return. Losses form a normal, expected part of trading, and risk management tools such as stop-loss orders and appropriately sized positions help address them. Drawdown differs: it measures the cumulative decline in your account over time, across a run of trades, rather than the outcome of any one trade.  

Drawdowns limit your ability to generate consistent returns: the deeper they run, the harder they make it to recover lost capital. A 50% drawdown, for example, requires a 100% gain just to return to the starting point. The recovery table further down this guide illustrates why: the percentage gain required to recover grows faster than the percentage lost.  

Volatility and drawdown are related, but they measure different things. Volatility describes how much and how quickly prices move, in either direction, over a given period. A market or strategy can be volatile without producing a large drawdown, if the ups and downs roughly cancel each other out.  

Drawdown, by contrast, only measures the decline from a peak. It's a directional, cumulative figure, and it depends on the order losses happen in, not just their size. Two strategies with identical volatility can have very different drawdowns, depending on whether their losing trades are spread out or bunched together. This is one reason risk management looks at both measures rather than relying on volatility alone.  

Different types of drawdown provide different perspectives on potential losses and account performance. Some measure account balance (closed trades only), while others measure equity (account balance plus or minus any unrealised profit or loss on open positions). Understanding the distinction can help you assess drawdown more accurately, as results may differ depending on the method used.  

Floating drawdown refers to the unrealised losses on your active trades before you close them. It reflects your equity rather than your balance, and it fluctuates as market conditions change while a position stays open.  

Say for example, you enter a long position on GBP/USD at 1.2500 and the price drops to 1.2450: that’s a floating drawdown of 50 pips. If the price then rises back above your entry level before you close the trade, the drawdown disappears.  

Monitoring floating drawdown shows whether your strategy can withstand short-term volatility without forcing you to close positions early.  

Fixed drawdown represents the losses that have been realised by closing trades. Unlike floating drawdown, these losses are permanent and directly reduce your account balance. For example, if you start with £10,000 and a run of losing trades reduces your balance to £9500, your fixed drawdown is £500. 

Absolute drawdown measures the total decline in your account balance from your initial deposit. It highlights the maximum fall in your account balance measured against your initial deposit, showing how much of your starting balance you’ve lost. 

Absolute drawdown = initial balance – lowest balance reached 

For example, if you deposit £5000 and your balance drops to £4200 before recovering, your absolute drawdown is £800. This metric gauges your strategy’s resilience, and whether your initial exposure to risk holds up sustainably over time.  

Relative drawdown expresses your decline as a percentage of your highest account balance, or peak equity. Because it adjusts for account growth, it gives a more dynamic read on risk and supports a consistent risk-reward ratio as your balance changes.  

Relative drawdown = ((peak balance – lowest balance) / peak balance) x 100 

For example, if your account reaches a peak of £12,000 and then drops to £10,500, the relative drawdown is: 

((£12,000 - £10,500) / £12,000) x 100 = 12.5% 

Initial drawdown is the first significant decline in your account balance from its starting value. It gauges how much risk you’re exposed to right after you begin a strategy, and whether that lines up with your risk tolerance.  

Initial drawdown = peak balance – lowest balance 

For example, say you start trading with £10,000. After a run of losing trades, your account value drops to £9200 before recovering. Your initial drawdown is: 

£10,000 - £9200 = £800 

Maximum drawdown (MDD) marks the largest peak-to-trough decline your account has experienced over a given period, before it sets a new peak. It stands out as arguably the single most useful drawdown figure, because it shows the worst outcome your strategy has produced, rather than an average or a best case.  

Breaking it down: 

• Peak: the highest equity your account reached before the decline began
• Trough: the lowest equity reached before a new peak was set
• Depth: the size of the fall from peak to trough, shown as a percentage
• Recovery: the point at which your equity climbs back above the previous peak

Keeping the division separate from the subtraction, the formula reads: 

Maximum drawdown = ((peak equity – trough equity) / peak equity) x 100 

For example, imagine your account grows from £10,000 to a peak equity of £15,000, then falls to a trough of £12,000 before recovering. Here: 

((£15,000 - £12,000 / £15,000) x 100 = 20% 

A 20% maximum drawdown means you lost 20% of your peak capital before recovering. As the recovery table below shows, getting back from a 20% drawdown to that £15,000 peak takes a 25% gain on the £12,000 trough, not 20%. A lower MDD generally points to more controlled risk management, while a high MDD can signal that a strategy is taking on excessive risk.  

Because percentage losses and percentage gains are not symmetrical, the percentage gain required to recover from a drawdown is greater than the percentage loss incurred. The table below illustrates the percentage gain required to return to the previous account value following different levels of drawdown. 

Table for illustrative purposes only. 

The table illustrates how the percentage gain required to recover increases as the size of the drawdown grows. Understanding this relationship may help when assessing account performance and considering risk management measures, such as position sizing and the use of leverage. However, there is no guarantee that losses can be recovered, and past performance is not a reliable indicator of future results. 

Here’s how maximum drawdown and recovery work together in practice.  

Say you start trading with £6000. A strong run of trades takes your account to a peak equity of £10,000. A subsequent losing streak, driven by a string of trades opened during a period of unexpected volatility, brings your equity down to a trough of £7,000 before it stabilises.  

Maximum drawdown: ((£10,000 - £7000) / £10,000) x 100 = 30% 

Gain required to recover: ((£10,000 - £7000) / £7000) x 100 = 42.9% 

A 30% maximum drawdown marks a meaningful decline, sitting at the moderate-to-high end of the risk tiers covered below. In this example, the losing streak coincides with larger position sizes than usual and wider stop-losses than the account can comfortably absorb. Reviewing the pattern points to a few contributing factors: position sizes that outgrew the account’s typical risk budget, stop-losses set wider than the volatility at the time justified, and leverage that amplified the resulting losses. 

None of this guarantees a full recovery, or that it happens within any particular timeframe. It does, however, identify the conditions that caused the drawdown, rather than just the balance itself. 

The drawdown you’re willing to accept depends on your risk tolerance, strategy and goals. No universal threshold exists, so understanding the relationship between risk and drawdown matters more than chasing a specific number.  

The risk tiers below are for illustrative purposes only and describe a general, hypothetical relationship between risk tolerance and typical drawdown ranges; they are not guarantees, and actual drawdown can be higher, since your full capital is at risk. CFDs are inherently a high-risk product, and the ‘low’, ‘moderate’ and ‘high’ labels below are relative comparisons between trading styles, not a suggestion that any approach is low risk in absolute terms. 

• Low risk: with a low risk tolerance, your drawdowns typically stay below 5-10% of your account balance. Smaller position sizes, tighter stop-loss orders and lower-volatility markets may help preserve your capital in this range, and diversified positions further limit your exposure. 
• Moderate risk: with a moderate risk tolerance, your drawdown levels typically run higher, usually in the 10-20% range, as a trade-off for potentially higher returns. This typically pairs short-term losses with longer-term gains, controlled leverage, diversified positions, and a defined risk-reward ratio. 
• High risk: trading more aggressively, with higher leverage and larger position sizes, typically means tolerating higher drawdown levels yourself, potentially exceeding 20-30%. This approach can produce larger gains, but it also raises your chances of an account wipeout (losing your entire balance). A clear short-term focus, a defined recovery plan and a platform built for fast trade execution all limit your losses at this level of risk.

Drawdown analysis forms a core part of risk management, and it helps judge whether a strategy is sustainable over the long run. Understanding the relationship between drawdown, risk exposure and account performance can help provide context when assessing trading outcomes and considering risk management measures. However, drawdown levels alone should not be relied upon when making trading decisions, and past performance is not a reliable indicator of future results. 

A strategy’s performance is often assessed not only by its returns, but also by how it performs during periods of losses. Lower levels of drawdown generally result in a smaller reduction in account value during periods of decline, which may affect overall performance over time.  

Drawdown can also be relevant when considering compounding. As covered above, larger drawdowns require disproportionately larger gains to recover from, which may be difficult to achieve. Understanding the relationship between drawdown and recovery can help you assess the impact of losses on your account over time. Recovery from losses is not guaranteed, and past performance is not reliable indicator of future results.  

Excessive drawdown can wipe out an account entirely, ruling out further trading without a fresh deposit. Understanding your drawdown tolerance, alongside the risk management techniques covered in the next section, may help reduce the risk of unprepared losses forcing you out of the market. However, these measures do not guarantee against an account wipeout, and losses can still occur. 

Managing drawdown effectively sits at the centre of trading sustainably over the long term. Risk controls like position sizing, leverage management and diversification may help minimise potential losses and keep your approach workable when markets move against you. However, they do not guarantee that your capital will be preserved or that losses can be avoided.  

A few risk-management habits reduce how likely you are to experience severe drawdowns: 

• Position size: trade sizes that reflect your account balance and risk tolerance limit how much a single loss can dent your overall capital. For example, a 1-2% risk per trade is a commonly used guideline.
• Leverage: leverage levels for retail clients are fixed by asset class under FCA rules, and higher leverage increases both potential profits and drawdown risk. Even within these limits, leverage raises the chances of margin calls or, in the worst case, an account wipeout.
• Diversification: spreading your capital across different assets, markets or positions may reduce concentration risk by limiting your exposure to any single asset, market movement or trading outcome. However, diversification does not eliminate risk and losses can still occur.

Adjusting how your capital is allocated across assets is another way to consider drawdown, as changing market conditions can alter your portfolio’s weighting and increase your exposure to particular assets or markets over time.  

If drawdown becomes elevated, or market conditions become unstable or uncertain, some traders may consider: 

• Reducing exposure to highly volatile assets 
• Allocating more capital across assets with different risk characteristics
• Reviewing position sizes in light of prevailing market conditions

Portfolio rebalancing does not eliminate risk, guarantee profits, or prevent losses. Its effectiveness will depend on individual circumstances, market conditions, and the assets involved. 

Stop-loss orders can be used to limit your exposure to losses by automatically closing a position when the market reaches a specified price level. Two main types exist: 

• Fixed stop-losses close a position at a predetermined price level. However, in fast-moving markets they may be filled at the next available price rather than the exact level set.
• Trailing stop-losses adjust as the market price moves, which may help lock in gains while continuing to limit exposure to losses. 

Both are available on Pepperstone’s trading platforms and can be set when opening a position. However, stop-loss orders do not guarantee protection against all losses, particularly during periods of significant market volatility or gapping. 

Drawdown is a common feature of trading, but how you respond to it can influence your overall trading experience. Responding to periods of drawdown may involve reviewing the factors that contributed to it, considering whether any adjustments to your approach are appropriate, and maintaining a disciplined approach while doing so.  

Working out what actually caused a drawdown comes before changing how you trade in response to it. Were market conditions, such as news events, economic shifts or unexpected volatility, the main driver? If so, deeper pre-trade research can inform the next approach. Or did mistakes in the trading itself, like excessive leverage, weak risk management, or straying from a plan, play a part? Reviewing your trades surfaces the patterns that limited your performance.  

Once the cause is clear, adjusting your strategy, for example by reducing trade size or risk exposure, can help to limit the impact of future drawdowns while your confidence rebuilds. 

Emotional control matters as much as strategy when you’re navigating a drawdown. Discipline and a structured recovery plan typically involve:  

• Taking a measured approach: accepting that the drawdown has occurred and considering any adjustments carefully, rather than making reactive trading decisions. This is sometimes referred to as revenge trading, where trading activity is influenced by an attempt to recover recent losses.
• Practising patience: recognising that recovering a balance can take time. Trading with excessive risk to chase losses back tends to make drawdowns worse, not better. 

A short break from trading can also restore focus, reducing decisions driven by frustration or urgency.  

What is a good drawdown percentage? 

There is no single drawdown percentage that can be considered ‘good’ or appropriate for all traders. The level of drawdown experienced will depend on a range of factors, including market conditions, trading activity, the use of leverage, and an individual’s approach to risk. What matters most is understanding the relationship between drawdown and risk exposure, and considering whether the level of drawdown experienced remains consistent with your objectives and overall risk management approach. 

What causes drawdown? 

Drawdown usually arises from a combination of losing trades, adverse market movements, and overall trading activity. Common contributors can include larger position sizes, concentration in a single asset or market, a lack of diversification, or trading through periods of increased volatility or significant market events without reviewing overall risk exposure. 

Can drawdown be avoided? 

Not entirely. Losses form a normal part of trading, making some drawdown close to unavoidable over time. Position sizing, stop-loss orders and diversification manage its depth and duration; none of them eliminate it altogether.  

How long can recovery from drawdown take? 

No fixed timeframe applies. Recovery depends on the depth of the drawdown, market conditions, and how you adjust afterwards. Because the gain required to recover accelerates as drawdown deepens (see the recovery table above), deeper drawdowns generally take proportionally longer to recover from than shallow ones.  

What's the difference between drawdown and loss? 

A loss is the negative outcome of a single trade. Drawdown measures the cumulative decline in your account from a peak to a trough across a run of trades or a period of time, capturing the combined effect of a losing streak rather than any one result.