When most new traders start, they're obsessed with profits. How much can I make this week? This month? But the truth is that real trading success isn't about how much you earn, it's about how well you manage what you lose.

That's where drawdown comes in. Drawdown tells you how much your trading account falls from its highest point before recovering. It's a simple but powerful way to measure risk, performance, and emotional discipline.

Even some good investments experience drawdowns now and then, but what causes drawdowns, and how can one manage risks to minimize drawdowns and maximize profit? In this guide, we will educate you on what a drawdown is in trading and how to avoid or minimize them while trading.

What is Drawdown in Trading?

If you invested $200,000 in a stock, and your $200,000 investment grew to $250,000 and then dropped to $125,000, you lost 50 percent of that stock, and this loss is called a drawdown.

Drawdown in trading refers to the peak-to-trough decline in the value of an investment, portfolio, or trading account. Traders measure the largest loss an investment has experienced from its highest value to its lowest value before recovering.

Since traders set up trades with the hope of making profits, the truth is that not every trade made will return profits. But that is the essence of taking risks. Drawdown is an important risk management metric, helping investors and traders assess potential losses and make informed decisions before making a trade.

In day trading, where positions are opened and closed within the same day, drawdowns are typically smaller in size but occur more frequently. Because repeated losses can accumulate rapidly and impact total capital, day traders keep a close eye on these fluctuations to manage risk effectively.

How to Calculate a Drawdown

Here's a simple way to calculate drawdown: subtract the lowest value (trough) of your account from its highest value (peak), then divide the result by the peak value and multiply by 100 to get a percentage.

For example, in the case of the 50% loss, the drawdown is calculated from the peak value $250,000 to the trough $125,000. Resulting in a 50% drawdown as $125,000 is 50% below $250,000.

This means your portfolio lost 50% of its value before recovering, a key metric that shows how much your equity fell during a losing streak. Tracking drawdowns helps traders understand their risk exposure and maintain consistent growth over time.

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Classifications of Drawdown

Here are the types of drawdowns you should know about:

What's an Acceptable Drawdown Level?

Some traders have a level of drawdowns they can accumulate, but here is a guide:

• Conservative traders keep drawdown below 10–15%
• Moderate traders keep drawdowns under 20–25%
• Aggressive traders try not to go above 30% as that will be too risky.

The smaller your drawdown, the easier it is to recover. A 50% drawdown means you need a 100% gain just to break even.

How to Manage or Reduce Drawdown

Drawdowns help traders in a way to:

• Assess Risk: One has to pause and think about how much risk they are really taking, and what risks to avoid next trade.
• Drawdown also helps one identify when to pause and reassess your strategy. And develop new strategies to manage potential losses.

In order to manage or reduce drawdowns while trading, here are a few ways to effectively manage drawdowns:

• Use Stop-Loss Orders: Knowing when to set a stop loss order is essential in managing drawdowns, because large losses are hard to recover from. Have clear exit points for your trade, and instead of hoping for a bad trade to turn around, cut your losses early.
• Risk Only 1–2% per Trade: Small position sizes give you room to breathe when trades don't go as planned.
• Diversify: Don't tie your entire balance to one asset or one strategy. Spread your risk that way, and you can curtail losses when they come.
• Avoid Revenge Trading: In trading, you need to understand that losses happen. Overtrading to recover fast usually leads to bigger drawdowns. It is important to have strategies in trading to help you manage or avoid drawdowns.
• Review Your Strategy Regularly: For each strategy that did not work, spot recurring mistakes and make adjustments for better trades next time. Small losses can become deep cuts if you fail to assess your strategies.

RELATED READ: Is Day Trading Profitable? (2025 Guide)

Final Thoughts

Drawdown isn't just a technical term but a mirror reflecting how well you handle losses. Every trader, no matter how experienced, will face drawdowns. What separates consistent traders from emotional ones is how they respond.

Instead of fearing drawdowns, learn from them. Keep your risk per trade small, diversify your positions, and always stick to your stop-loss. By focusing on minimizing your downside, you'll naturally improve your upside, and that's how smart traders stay profitable in the long run.

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