The decline in an investment or trading account from its peak value to a subsequent low. It’s a key metric used to assess the risk and performance of a trading strategy. A smaller drawdown indicates better capital preservation, while a large drawdown suggests higher risk and potential instability. Traders monitor drawdowns to evaluate whether their strategies remain effective over time. Managing drawdowns involves setting stop-losses, reducing position sizes, and avoiding overleveraging. It’s also a psychological tool, helping traders recognise when to pause or reassess their approach.
Example:
A portfolio declines from $200,000 to $170,000 before recovering, reflecting a temporary 15% drawdown.
