Drawdown, losing streaks and recovery

Define the equity series first

Drawdown measures the fall from a prior peak in a specified equity series. State whether equity includes open positions, deposits, withdrawals and costs. A realized-only balance can hide a large unrealized decline. A new deposit can raise account value without representing trading profit. Comparisons need the same accounting convention and observation interval.

Peak to trough arithmetic

If a hypothetical account falls from a $1,000 peak to $800, drawdown is ($1,000 − $800) / $1,000 = 20%. The dollar fall is $200. Recovering from $800 to $1,000 requires $200 / $800 = 25%, because the denominator is now smaller. A 20% loss and a 20% gain do not cancel: $1,000 × 0.8 × 1.2 = $960.

Fixed fractions compound

Losing a fraction f of remaining equity for n trades gives E(n) = E(0) × (1 − f)^n in a simplified model. At 2% for ten consecutive losses, $1,000 becomes approximately $817.07 before additional costs. The drawdown is about 18.29%, not exactly 20%. The dollar amount at risk falls as equity falls.

Fixed dollars follow a different path

Ten $20 losses reduce $1,000 to $800 before costs. The same $20 becomes a larger fraction of the shrinking balance. Do not label this as constant 2% risk. Neither example includes gaps, financing, rounding or liquidation constraints. A real position can lose more than an intended allowance, so the equations model assumptions rather than enforcement.

A streak is not evidence that a win is due

Even under independent trades with a known loss probability q, q^n describes one specified run of n losses. It is not the probability of seeing at least one such run anywhere in a longer sample. Real trades may also be dependent. A sequence of losses does not force the next outcome to reverse or justify increasing size.

Separate magnitude, duration and recovery

Maximum drawdown describes the largest observed peak-to-trough decline in the chosen sample. It does not describe how long recovery took, how many other declines occurred or how bad an unseen future event could be. Record peak date, trough date and time below peak. An uncompleted recovery must remain uncompleted in a report.

Explore assumptions locally

The drawdown scenario tool lets you compare constant fraction and constant dollar losses without placing an order. Changing the number of losses is a stress exercise, not a forecast of the next sequence. Compare the output with expectancy and portfolio-risk guides: a favorable average does not eliminate drawdowns or shared exposure.

Build a transparent record

Keep the original equity observations and mark external cash flows. State whether a graph is historical, simulated or a hypothetical repeated-loss calculation. Never describe a smooth synthetic path as a backtest. Use the exercise to explain why the recovery percentage differs from the decline percentage; no universal acceptable drawdown is selected here.