Drawdowns and recovery maths

A drawdown is the fall in your account from its highest point to a later low. Every trader has them. This lesson shows why large drawdowns are so hard to climb out of, and the simple limits that keep them small.

The asymmetry of losses

Losses and gains are not symmetrical. If you lose 50% of your account, a 50% gain does not get you back to where you started. You need 100%.

The reason is that the gain is calculated on a smaller balance. The general rule is:

• Gain needed to recover = loss ÷ (1 − loss)

Worked example

You start with 10,000 USD and fall to 8,000 USD, a 20% drawdown. To get back to 10,000 USD you need to make 2,000 USD on a balance of 8,000 USD: 2,000 ÷ 8,000 = 25%. Using the formula: 0.20 ÷ 0.80 = 0.25.

Recovery table

Small drawdowns are easily repaired. Past roughly 30%, the gain needed starts to climb steeply, and past 50% recovery becomes very difficult in practice. That is the arithmetic behind keeping risk per trade small.

Losing streaks are normal

It is natural to assume that a strategy which wins half the time will alternate wins and losses. It will not. Runs of losses happen by chance, and over many trades they are almost certain.

As an illustration, over 100 independent trades:

These figures assume each trade is independent with a constant win rate, which real trading only approximates. The message still holds: plan for long losing streaks before they happen.

What a streak costs

At 1% risk per trade, seven losses in a row takes you to about 0.99 to the power of 7 = 93.2% of your balance, a drawdown of roughly 6.8%. At 5% risk, the same streak leaves about 69.8%, a drawdown of about 30.2%, which needs a 43% gain to recover.

Daily and weekly loss limits

Per-trade risk controls a single loss. Loss limits control a bad day or a bad week, when frustration can lead to rushed decisions. Examples of rules traders use:

• Daily limit: stop trading for the day after losing 2% to 3% of the account, or after three losing trades.
• Weekly limit: stop for the rest of the week after a 5% to 6% fall.
• Drawdown review: if the account is 10% below its peak, halve your risk per trade until you have reviewed your journal and found the cause.

The exact numbers are personal. What matters is that you set them in advance, write them down and follow them when it is uncomfortable.

Leverage and gaps

A stop-loss limits losses only if the market trades at or near your stop price. Sometimes it does not.

• Weekend gaps. Forex closes on Friday evening and reopens on Sunday evening. News over the weekend can make Monday's opening price very different from Friday's close.
• News spikes. Around major announcements, prices can jump several pips at a time, and liquidity can thin out.

Worked example: a gap through your stop

You hold 0.40 lots of EUR/USD with a 25-pip stop, risking 100 USD (1% of 10,000 USD). The market reopens 80 pips against you, well beyond your stop. Your order fills at the first available price:

• Loss = 0.40 lots × 80 pips × 10 USD = 320 USD, or 3.2% of the account rather than the 1% you planned.

High leverage makes this worse, because a larger position turns the same gap into a larger loss. Many traders reduce size or close positions before weekends and major events for this reason. Most retail CFD accounts lose money, and uncontrolled leverage is a common cause.

Key takeaways

• Gain needed to recover = loss ÷ (1 − loss): a 20% drawdown needs 25%, a 50% drawdown needs 100%.
• Losing streaks of five or more are very likely over 100 trades, even with a 50% win rate.
• At 1% risk, seven straight losses cost about 6.8%; at 5% risk they cost about 30%.
• Set daily and weekly loss limits in advance and stop trading when you hit them.
• Gaps and news spikes can push losses beyond your stop, and leverage magnifies the damage.