Drawdown in a Trading Strategy – What Are Good Max Drawdowns?

Why is drawdown in trading important? Why should you spend time thinking about what is a good max drawdown percentage? How you prepare and deal with drawdowns in trading is important. Why is it important? Because a drawdown makes you fiddle, change, abandon your strategies, or stop trading altogether. Thus, a good trading plan deals with drawdowns before they inevitably happen. Our anecdotal experience indicates most traders and investors (including ourselves) underestimate their risk tolerance. What looks tolerable in backtesting is not as straightforward when dealing with real money and real losses.

A good max drawdown is less than 25%. To handle, reduce, and decrease inevitable drawdowns, we suggest trading small, trading many markets and time frames, but above all, make sure you trade within a wide margin of risk tolerance. To minimize drawdowns, you need to be prepared!

Max drawdown is important in trading because it influences your behavior and, obviously, your returns. Both are dependent on each other. What is a good or acceptable drawdown percentage? There is no definite answer, but preferable to be as low as possible. If it gets too big, more than 25%, many traders lose hope and stop trading. Thus, 25% can serve as a heuristic for max drawdown. Most traders believe they can handle bigger drawdowns, but we believe they overestimate their pain tolerance.

In this article, we look at why you should focus just as much on drawdowns as profitability.