What Is Drawdown
Drawdown (DD) is the decline in the value of a trading portfolio or account, measured from the highest point it has reached (the Peak) down to the lowest point (the Trough) before the account recovers and sets a new high. It's usually expressed as a percentage of capital, showing how far the account has fallen from its previous best.
A simple example: say your trading account grows from $10,000 to $15,000, then loses value steadily down to $12,000 before recovering. The drawdown for this stretch is (15,000 − 12,000) ÷ 15,000 × 100 = 20%
Drawdown is a risk metric that matters just as much as returns, because it shows how much pain a strategy or trading style causes when the market moves against it — unlike cumulative profit, which only shows the end result without capturing the journey.
Types of Drawdown
1. Floating Drawdown
This is an unrealized loss that occurs while a position is still open. If price reverses, the account value can recover without the loss ever being locked in. But if price keeps moving against the position, floating drawdown can turn into a realized loss.
2. Fixed (Realized) Drawdown
This is a loss that has already occurred after a losing trade has been closed. It's a permanent reduction in capital until it's made back with future profits.
3. Maximum Drawdown (MDD)
This is the deepest drawdown recorded over a given period, measured from the highest peak to the lowest trough. Traders and fund managers commonly use this figure as a risk benchmark for a strategy, since it reflects the worst outcome that has actually happened.
How to Calculate Drawdown
The formula for drawdown as a percentage at a given point in time is:
Drawdown (%) = (Current Account Value − Previous Peak) ÷ Previous Peak × 100
Maximum Drawdown, meanwhile, is the deepest drawdown recorded across every cycle within the period being reviewed — not just the most recent one.
Worked Example
Say starting capital is $5,000, it grows to $6,000, then falls to $4,000, before eventually recovering to $7,000.
- The peak for this cycle is $6,000
- The trough is $4,000
- Drawdown = (6,000 − 4,000) ÷ 6,000 × 100 = 33.3%
Even though the account later recovers and sets a new high at $7,000, the Maximum Drawdown for this cycle is still recorded as 33.3% — a record of the real risk taken along the way.
Why Drawdown Matters So Much in Forex Trading
Forex is a market that runs on high leverage, which magnifies both profits and losses at the same time. A strategy that looks fairly stable on paper can produce a severe drawdown once leverage is pushed too high. Failing to understand or control drawdown can wipe out an account entirely.
It's worth remembering that the level of investor protection you get depends heavily on which regulated entity you actually open your account with. A broker authorised by a well-established regulator — such as the FCA in the UK, ASIC in Australia, or CySEC in Cyprus — typically comes with segregated client funds and a formal complaints process, while an unregulated or loosely regulated entity offering very high leverage does not offer the same safety net if something goes wrong.
What many traders overlook is that the deeper the loss, the disproportionately larger the profit needed just to break even, as shown in the table below.
| Loss From Peak (Drawdown) | Profit Needed to Break Even |
|---|---|
| 10% | 11.1% |
| 20% | 25% |
| 30% | 42.9% |
| 40% | 66.7% |
| 50% | 100% |
| 60% | 150% |
| 70% | 233% |
| 80% | 400% |
The table shows that a 50% loss requires a 100% gain just to get back to where you started, and an 80% loss requires a 400% gain, which is close to impossible in practice. This is why controlling drawdown from the outset matters more than chasing the biggest possible profit.
Drawdown and Prop Firm Rules
For traders interested in prop firms (companies that fund traders with their own capital), drawdown rules are one of the most critical conditions to understand. FTMO, one of the best-known prop firms globally, sets a Daily Drawdown limit of 5% per day and a Maximum Drawdown limit of 10% of the initial balance across the account's lifetime. On a $100,000 account, that means losses cannot exceed $5,000 in a single day, or $10,000 across the account's lifetime. Breach either limit, and the account is closed immediately.
Rules like these make per-trade risk management even more critical, since risking 3–4% per trade can be enough to breach the drawdown limit after just a few losing trades in a row.
How to Manage and Control Drawdown
1. Use a 1–2% Risk-Per-Trade Rule
Most professional traders stick to risking no more than 1–2% of total capital on any single trade, so the account can withstand a string of losses without serious damage. At 1% risk per trade, it would take 100 consecutive losing trades to wipe out the account — something almost no viable trading system would ever produce.
2. Always Set a Stop Loss
Failing to set a stop loss is one of the leading causes of drawdown spiralling out of control, simply because there's no defined point at which the loss is cut.
3. Keep Leverage Under Control
High leverage means even small price moves can have an outsized impact on account value. Choosing leverage that suits your capital size and trading style reduces the chances of a severe drawdown.
4. Set a Personal Drawdown Ceiling
Many traders set their own rule — for example, if the account falls 10–15% from its peak, they stop trading immediately to review their strategy, rather than pushing on to try to "win it back".
5. Diversify Risk and Avoid Unplanned Averaging Down
Avoiding concentrated risk in a single currency pair, and avoiding adding to losing positions to average down the entry price without a clear risk plan, both help keep drawdown from spiralling.
Conclusion
Drawdown is one of the most important risk metrics for any forex trader, because it shows just how much pain your capital could take in a worst-case scenario. Understanding how to calculate drawdown, and how it affects an account's ability to recover, helps traders build better risk management — from position sizing to setting stop losses to controlling leverage — so they can survive in the market over the long run, rather than chasing quick profits while ignoring the risk building up underneath.
Frequently Asked Questions (FAQ)
How is drawdown different from an ordinary loss?
An ordinary loss looks at total profit and loss at a single point in time, while drawdown looks at the distance between an account's peak and its lowest point. That makes drawdown a better way to capture the volatility and risk taken along the way — something a net profit figure alone doesn't show.
How much drawdown is considered dangerous?
There's no fixed number, but professional traders and prop firms commonly cap Maximum Drawdown at around 10–20%. Beyond that, a strategy is generally considered high-risk and its risk management should be reviewed.
What should you do when an account is in a deep drawdown?
Reduce position size, review the strategy currently in use, and avoid rushing to "win it back" by increasing risk. As the table above shows, the deeper the loss, the disproportionately larger the profit needed just to break even.
Sources: Compare Forex Brokers – What is a Drawdown in Forex, FTMO – Trading and Drawdowns
