Drawdowns and recovery
Drawdowns are part of trading, but their size and duration can affect both account equity and decision-making. This lesson explains how to measure a drawdown, why recovering a loss requires a larger percentage gain, and how a structured risk process can help you respond without increasing exposure simply to recover losses.
What is a drawdown?
A drawdown is a decline in account value from a previous peak. It continues until the account reaches that peak again, although it may deepen or narrow along the way. Maximum drawdown is the largest peak-to-trough decline within a specified period. It describes past losses; it does not place a limit on future losses.
Drawdowns can be measured using balance or equity, but the distinction matters. Balance generally reflects completed transactions, while equity also includes unrealised profits and losses on open positions. Watching balance alone can hide losses that are still open. On MT5, balance and equity are displayed separately, so identify which measure you are using before comparing results.
Measure depth and duration
To calculate percentage drawdown, subtract current equity from the previous equity peak, divide the difference by that peak, and multiply by 100. Use the same measurement basis throughout. Deposits and withdrawals can distort the comparison: adding money may lift equity without recovering any trading losses. A performance record should distinguish cash movements from trading results.
Depth is only one part of the picture. Duration measures how long the account remains below its previous peak. Two accounts can experience the same percentage decline but take very different amounts of time to recover, and recovery is not guaranteed. The measurement period and frequency also matter: daily snapshots may miss a deeper decline that occurred during the trading day.
Worked example: recovery maths
Suppose a hypothetical account reaches an equity peak of USD 10,000 and then falls to USD 8,000, with no deposits or withdrawals. The loss is USD 2,000, and the drawdown is (2,000 ÷ 10,000) × 100 = 20%. Returning to USD 10,000 requires gaining the same USD 2,000, but from a smaller base. The required recovery gain is therefore (2,000 ÷ 8,000) × 100 = 25%, not 20%.
The general formula is: required recovery gain (%) = drawdown (%) ÷ [100 − drawdown (%)] × 100. A 10% drawdown requires about 11.1% to recover, while a 50% drawdown requires 100%. These figures assume no cash movements and that account results include trading costs. They explain the arithmetic, not the likelihood or speed of recovery. After a complete loss of equity, a percentage gain on the remaining zero balance cannot restore the account.
How risk shapes drawdowns
Position size affects how strongly a price move changes account equity. Leverage allows a relatively small amount of margin to support a larger exposure; margin required is not the same as the amount at risk. CFDs are leveraged products and carry a high risk of loss. Losses can also accumulate across positions that respond to the same market factor, even when they involve different instruments.
As the previous lesson explained, volatility, gaps and slippage can make realised losses larger than planned. A stop-loss order does not guarantee execution at its specified price. If position size stays unchanged while equity falls, the same cash loss becomes a larger percentage of the remaining account. A risk framework can account for this by linking exposure limits to current equity rather than only to the original deposit.
Respond with a defined process
A drawdown response is easier to assess when its rules are written before losses occur. A framework might define review thresholds, limits on combined exposure, or conditions for pausing new trades. These are process controls, not guarantees against further losses. Any threshold should be understood in relation to the strategy, available capital and the possibility that market conditions or execution differ from expectations.
During a review, separate normal variation from execution mistakes, rule breaches and changes in market behaviour. Records can include equity, position sizes, costs and reasons for each decision. Increasing exposure merely to return quickly to a previous peak can deepen losses. Recovery has no fixed timetable, and returning to a peak does not prove that risk controls were sound. The next lesson explores the psychology and discipline behind following a consistent process.
- Measure drawdowns consistently, including unrealised losses when tracking equity.
- Recovery requires a larger percentage gain than the percentage lost.
- Drawdown depth and duration both matter; recovery is not guaranteed.
- Defined risk controls support discipline but cannot eliminate CFD losses.