Drawdown
Drawdown is how far an account or a strategy falls from its highest value before it recovers. If equity rises to a peak and then drops, the drop from that peak to the following low is a drawdown, usually given in percent of the peak. Maximum drawdown is the largest such fall over a period.
Why it matters
Total return shows where a strategy ended. Drawdown shows what it took to get there. Two strategies with the same return can feel completely different: one rises steadily, the other halves before it recovers. Most traders stop a strategy during a deep drawdown, often just before it would have recovered, so the drawdown you can live through matters more than the best possible return.
Drawdowns also compound against you. After a fall of half the account, the remaining money must double to get back to the peak.
Reading drawdown in a backtest
- Compare the maximum drawdown with the return. A high return with an even higher drawdown is a fragile result.
- Look at how long drawdowns last, not only how deep they are.
- Expect worse live. A backtest shows the worst drawdown of the past, not of the future.
Limiting it
A stop loss on every trade, risk-based position sizing and a daily loss limit keep single trades and bad days from turning into deep drawdowns.
On Algonney every backtest shows the equity curve, the drawdown curve and the maximum drawdown next to the trades.
Related: R-multiple, backtesting, Backtesting and Crypto risk management.