The Mathematics of Drawdown
One of the most important, and most overlooked, concepts in trading is the asymmetry between losses and gains. A loss of 50% does not require a 50% gain to recover. It requires a 100% gain.
Recovery Needed = (1 ÷ (1 - Drawdown%)) - 1
| Drawdown | Recovery Needed | Severity |
|---|---|---|
| 10% | 11.1% | Manageable |
| 25% | 33.3% | Significant |
| 50% | 100% | Severe |
| 75% | 300% | Critical |
How to Prevent Deep Drawdowns
- Set a maximum daily loss limit
- Reduce position size when drawdown reaches 10%
- Never add to losing positions