Drawdowns and risk of ruin

A drawdown is the fall from an account's peak to a subsequent low. Every trading approach has them. The question is not whether they happen but how deep they go and whether the account and the trader can survive them.

The asymmetry of losses

Losses and the gains needed to recover from them are not symmetrical. A 10% loss needs an 11% gain to recover. A 25% loss needs 33%. A 50% loss needs a 100% gain just to return to the starting point. The deeper the drawdown, the harder the climb back, which is why controlling the size of drawdowns matters more than avoiding every loss.

Losing streaks are normal

Even an approach that wins more often than it loses will produce long losing streaks over enough trades, purely by chance. A sizing method that seems comfortable on paper can become painful during a streak that is statistically ordinary.

Risk of ruin

Risk of ruin is the probability of an account falling to a level from which it can no longer trade effectively. It rises sharply as the share of the account risked per trade increases, and as the true edge shrinks or turns out to be smaller than estimated.

Process controls

• Daily and weekly loss limits that end trading for the period once reached.
• A maximum drawdown level that triggers a full review before trading continues.
• Reducing size during drawdowns rather than increasing it to recover faster.

Educational content only. Not financial advice.