Lesson 05 of 8 · Risk and Money Management
22 min4 topics
Topic 1 of 4
A drawdown is the fall from a peak in your balance to the low that follows it. Every strategy has them, including good ones. What makes them dangerous is not their size but their arithmetic: recovering from a loss always takes a bigger gain than the loss itself, and the gap widens faster than intuition expects.
Lose 50% and you need 100% to get back. This is not a trick of presentation. It is that the gain is calculated on the smaller balance that is left.
What each variable means:
| Drawdown | $10,000 becomes | Gain needed to recover |
|---|---|---|
| 5% | $9,500 | 5.3% |
| 10% | $9,000 | 11.1% |
| 20% | $8,000 | 25.0% |
| 30% | $7,000 | 42.9% |
| 40% | $6,000 | 66.7% |
| 50% | $5,000 | 100.0% |
| 75% | $2,500 | 300.0% |
| 90% | $1,000 | 900.0% |
The first three rows are survivable and the last three are usually not — not because the money is unrecoverable in principle, but because the trading required to recover it is nothing like the trading that produced the edge. Needing 300% back is the point at which a disciplined trader starts taking undisciplined trades.
Caution
This is the arithmetic behind every rule in this track. Small consistent risk is not caution for its own sake; it is the only way to keep drawdowns inside the range where ordinary trading gets you out of them.
You do not have to wait to find out how deep your drawdowns go. Two inputs give a usable estimate: your risk per trade, and the longest losing streak your win rate will produce.
A 40% win rate means each trade has a 60% chance of losing. The chance of six in a row is 0.6 to the sixth power — about 4.7%. Over 200 trades, a run of six or more is not unlikely; it is close to certain.
| Win rate | Streak you should plan for in 200 trades |
|---|---|
| 60% | About 6 losses |
| 50% | About 8 losses |
| 40% | About 10 losses |
| 30% | About 14 losses |
At 2% risk per trade on $10,000, each loss is smaller than the last because the balance shrinks:
| Losses in a row | Balance | Drawdown | Recovery needed |
|---|---|---|---|
| 5 | $9,039 | 9.6% | 10.6% |
| 10 | $8,171 | 18.3% | 22.4% |
| 15 | $7,386 | 26.1% | 35.4% |
| 20 | $6,676 | 33.2% | 49.8% |
| 30 | $5,455 | 45.5% | 83.3% |
Read that against the streak table. A 40% win-rate system at 2% risk should expect to visit a 20% drawdown, and the trader who has not decided in advance that this is normal will abandon a working method somewhere around loss eight.
Try it now
The drawdown calculator runs this for your own balance, risk and streak length, and reports the recovery each level requires.
The hardest question in a drawdown is whether to keep going. Both answers are expensive when wrong: stopping a working system wastes the edge, and continuing a broken one empties the account.
Three questions separate them, and none is about how it feels.
If the answers are within expectation, yes, and no, the drawdown is the cost of the edge and the correct action is to keep trading the same way at the same fraction.
Note
Note that the honest version of question 2 requires a journal written before the outcomes were known. This is where Track 7 pays for itself: without a record, every drawdown is indistinguishable from a broken system, because memory rewrites the reasoning to match the result.
Decide now, in the calm, what drawdown makes you stop. Written in advance it is a rule; invented at the time it is a panic.
Then halve the size rather than stopping outright, if stopping entirely is unrealistic for you. A trader at half size in a drawdown is still gathering information, still executing, and doing half the damage — which is a far better outcome than a rule so strict it gets ignored.
Good to know
Write the levels down where you will see them at the moment they bind — the top of your journal, a note on the monitor. A limit you have to recall under pressure is a limit you will negotiate with.
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