Max Drawdown, Explained for Strategy Testing
Max drawdown is the biggest drop your account or strategy took from a high point down to a low point before it made a new high. If your equity climbed to $10,000, fell to $7,500, then eventually recovered, your max drawdown was 25%. It's the single worst losing stretch in the period you're looking at, measured as a percentage from peak to trough. Traders care about it because it tells you the most pain a strategy has handed out historically, which is what really tests whether you'd stick with it or panic and quit. A strategy with great returns but a 60% drawdown is hard to actually hold through. Max drawdown also shapes how big your positions should be. Remember that the future can hand you a deeper drawdown than any you've seen in testing.
Max drawdown is the largest peak to trough drop a strategy took. Why it often matters more than total return when judging whether you could actually trade a system.
Key points
- Max drawdown is the largest drop from a peak in your equity down to the lowest point before a new peak is made.
- It's normally shown as a percentage, so a fall from $10,000 to $7,500 is a 25% max drawdown.
- The number tells you the worst pain a strategy has handed out in the period you're studying.
- It matters for whether you'd actually stick with a strategy, since deep drawdowns are what make people quit at the bottom.
- Time spent underwater, meaning how long it takes to climb back to the old high, is just as important as the depth.
- The future can always deliver a drawdown deeper than anything in your test, so plan position sizes with room to spare.
Frequently asked questions
What is max drawdown in simple terms?
It's the biggest peak-to-valley drop your account or strategy went through before recovering to a new high. If you were up to $10,000, sank to $8,000, then later made a new high, your max drawdown for that stretch was 20%. It measures your worst losing run.
What's an acceptable max drawdown?
It depends on the person and the strategy, but many traders get uncomfortable well before 30% to 40%. The real test is whether you could keep following the plan while sitting through that loss. If a drawdown would make you quit or change everything, it's too big for you.
What's the difference between a drawdown and a regular loss?
A single loss is one losing trade. A drawdown is the running decline from a high point, which can be made up of many trades in a row. Max drawdown zooms out to the single worst of these declines over the whole period.
How long does it take to recover from a drawdown?
There's no fixed answer, and the time underwater can be long. Getting back to even takes a bigger percentage gain than the percentage you lost, since a 25% loss needs about a 33% gain to recover. That's why deep drawdowns hurt twice: in depth and in recovery time.
Where can I see max drawdown for a strategy in Agenticks?
When the AlgoAgent backtests a strategy, it shows the max drawdown right next to the return and other stats, and it can point out how long the strategy stayed underwater. You just ask it to run the test, and it lays out the worst stretch in plain language.
Related on Agenticks
This content is for educational purposes only and does not constitute financial advice. Trading involves risk, including possible loss of capital.