This guide explains how to calculate maximum drawdown, why recovering from a drawdown is harder than it looks, related measures such as the Calmar ratio and time to recovery, and how to use drawdown to size and judge strategies.
How maximum drawdown is calculated
- Track the running peak of the equity curve: the highest value so far.
- At each point, calculate the drawdown: (running peak − current value) ÷ running peak.
- The maximum drawdown is the largest of these drawdowns.
Example. An account grows from ₹10 lakh to ₹12 lakh, falls to ₹9.6 lakh, rises to a new peak of ₹12.6 lakh, then falls to ₹11.34 lakh.
| Point | Value | Running peak | Drawdown |
|---|---|---|---|
| Start | ₹10.00 lakh | ₹10.00 lakh | 0% |
| Peak 1 | ₹12.00 lakh | ₹12.00 lakh | 0% |
| Low 1 | ₹9.60 lakh | ₹12.00 lakh | 20% |
| Peak 2 | ₹12.60 lakh | ₹12.60 lakh | 0% |
| Low 2 | ₹11.34 lakh | ₹12.60 lakh | 10% |
The maximum drawdown is 20%, or ₹2.4 lakh, even though the account ended above where it started.
Recovering from a drawdown
A drawdown of a given percentage needs a larger percentage gain to recover, because the recovery starts from a smaller base:
| Drawdown | Gain needed to recover |
|---|---|
| 10% | 11.1% |
| 20% | 25.0% |
| 30% | 42.9% |
| 40% | 66.7% |
| 50% | 100.0% |
In the example, the account fell 20% to ₹9.6 lakh and needed a 25% gain to get back to ₹12 lakh. This is why limiting drawdowns matters more than chasing returns.
Time to recovery
The depth of a drawdown is only half the story. How long it lasts matters too. A 15% drawdown that recovers in a month is very different from one that lasts two years. Track:
- Time underwater: from the peak to the point the account regains it.
- Longest drawdown: the longest time spent below a previous peak.
Many traders abandon good strategies during long drawdowns. Knowing the historical length in advance helps you stay with the plan, or decide in advance when a drawdown is long enough to stop.
The Calmar ratio
The Calmar ratio compares return with drawdown:
Calmar ratio = annual return ÷ maximum drawdown
A strategy returning 18% a year with a 20% maximum drawdown has a Calmar ratio of 0.9. Higher is better. Unlike the Sharpe ratio, it focuses on the worst decline rather than on volatility.
Why the backtest drawdown understates real risk
- One path. The backtest shows the drawdown of one sequence of trades. A different order of the same trades could produce a deeper one. Monte Carlo simulation estimates the range.
- Future events. The worst drawdown is always ahead of you, not behind you. A rule of thumb many traders use is to plan for a live drawdown larger than the backtest's.
- Optimism. Backtests often understate costs and slippage, which deepen drawdowns.
Using drawdown to size a strategy
If you can tolerate a 15% drawdown and a strategy's realistic worst-case drawdown is 30% at its current size, halve the size. Drawdown scales roughly with position size, so this is one of the most direct ways to fit a strategy to your risk tolerance. The position size calculator helps with the per-trade side.
Drawdown rules for live trading
- Daily limit: stop trading for the day after a set loss, with an MTM stop loss.
- Strategy limit: pause a strategy if its drawdown exceeds its expected worst case by a set margin, then review it.
- Account limit: reduce overall size after a set drawdown and restore it after recovery.
Decide these rules before trading, not during a drawdown.
Where to find your drawdown
QuantPower's backtesting engine shows the results of each strategy over past data, and live strategies show their P&L as they run. Our guide on how to backtest trading strategies explains which other metrics to read alongside drawdown.
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Frequently asked questions
What is maximum drawdown?
The largest percentage fall from a peak to a later low, before a new peak.
What is a good maximum drawdown?
It depends on the strategy and your tolerance. Many traders aim to keep realistic drawdowns below 15% to 25%. Compare drawdown with return using the Calmar ratio.
How long does it take to recover from a drawdown?
It depends on the depth and the strategy's returns. A 20% drawdown needs a 25% gain to recover; at 1.5% a month, that takes about 15 months.
Why is my live drawdown worse than my backtest?
Backtests show one path and often understate costs. Live markets can also produce events not seen in the backtest period.
Sources
- Young, T. W. (1991). Calmar Ratio: A Smoother Tool. Futures magazine
- Magdon-Ismail, M. and Atiya, A. F. (2004). Maximum Drawdown. Risk magazine