Risk management for traders · Lesson 2 of 4
The maths of drawdown
7 min
Losses and recoveries are not symmetrical
If an account falls by a fraction L, it needs a gain of L ÷ (1 − L) to get back to where it was.
| Drawdown | Gain needed to recover |
|---|---|
| Five percent | About five point three percent |
| Ten percent | About eleven point one percent |
| Twenty percent | Twenty-five percent |
| Thirty percent | About forty-three percent |
| Fifty percent | One hundred percent |
The larger the drawdown, the harder recovery becomes, and not in a straight line. That is why a trader's most important job is avoiding large drawdowns, not chasing large profits.
Losing streaks
Even a good strategy has losing streaks. At a fixed risk of one percent of the current balance:
- Five losses in a row: a drawdown of about four point nine percent
- Ten losses in a row: a drawdown of about nine point six percent
At five percent risk, ten losses in a row create a drawdown of about forty percent, which needs a gain of about sixty-seven percent to recover.
The practical lesson
Before each month begins, write down the drawdown you will accept, for example six percent. If you reach it, stop trading until the end of the month and review your journal. Investors and prop evaluators measure exactly this discipline.
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