Max drawdown explained: the peak-to-trough capital loss

By Ken Chigbo, Founder, KenMacro. Published 2026-05-12.

What is max drawdown?

Max drawdown (MDD) is the largest peak-to-trough decline in account equity over a defined measurement window. The figure is expressed as a percentage of the prior peak, not of starting capital. A strategy growing equity from 10,000 to 12,000 and then declining to 9,600 has a max drawdown of (12,000 minus 9,600) divided by 12,000, equal to 20 per cent. Drawdowns are calculated continuously, so the recorded MDD is the worst case across the entire history of the strategy. Recovery to a new equity high is the standard end-of-drawdown trigger; the equity must reclaim the prior peak before a new drawdown can be measured.

How traders use max drawdown

Traders treat max drawdown as the primary stress measure of any strategy, often more informative than Sharpe ratio for retail decisions. A strategy with 20 per cent annual returns and 5 per cent max drawdown is structurally easier to live with than the same returns at 30 per cent max drawdown, because the second strategy requires the trader to sit through losses that would push most retail traders to abandon the framework. The Calmar ratio (annual return divided by max drawdown) is a clean single-metric way to compare drawdown-adjusted performance. Prop firms typically impose maximum daily drawdown limits of 4 to 5 per cent and overall maximum drawdown limits of 8 to 10 per cent; these limits effectively cap trader behaviour at quarter-Kelly to eighth-Kelly sizing. The desk's deployed frameworks (OMEGA-25, SIGMA-X, EPSILON) target max drawdowns under 3.5 per cent on multi-year backtests with realistic costs applied.

Worked example with max drawdown

Consider three strategies, all returning 20 per cent annualised. Strategy A has 5 per cent max drawdown. Strategy B has 15 per cent max drawdown. Strategy C has 30 per cent max drawdown. The Calmar ratios are 4.0, 1.33, and 0.67 respectively. Strategy A is structurally exceptional; the prop-firm community considers any strategy with Calmar above 3.0 as institutional-grade. Strategy B is good retail quality. Strategy C, despite identical returns, is the hardest to actually trade: a 30 per cent drawdown in real time pushes most retail traders to abandon the framework, locking in the loss before recovery. Drawdown behaviour, not return, is the determinant of whether a strategy is actually tradeable.

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Frequently asked

What is a good max drawdown for a trading strategy?

A max drawdown under 10 per cent is excellent for a retail trading strategy. Under 20 per cent is good. Under 30 per cent is acceptable. Above 30 per cent makes a strategy structurally hard to live with in real time. Prop firms typically impose overall maximum drawdown limits of 8 to 10 per cent, which effectively constrains trader sizing to conservative levels.

How is max drawdown different from current drawdown?

Max drawdown is the worst peak-to-trough decline ever recorded across the strategy's history. Current drawdown is the present decline from the most recent equity peak. A strategy currently 5 per cent below its peak has a current drawdown of 5 per cent; if at some prior point it was 18 per cent below, its max drawdown is 18 per cent. Max drawdown only updates when a new worst case occurs.

What is the Calmar ratio?

The Calmar ratio is annual return divided by max drawdown. A strategy returning 20 per cent with 5 per cent max drawdown has a Calmar of 4.0. Calmar above 3.0 is considered institutional-grade. Calmar is often more informative than Sharpe for retail traders because it directly captures the relationship between reward and the worst-case stress an investor must endure.

Educational analysis only. Past performance does not guarantee future results. Manage risk against your own portfolio.