Max Drawdown is the largest peak-to-trough decline of an account's equity curve over a given period, expressed either in dollars or as a percentage of the prior peak. It captures the worst losing streak the account has actually lived through and is the single most relevant historical risk number, because it tells you the depth of pain a strategy has produced in the past — and a future drawdown will almost certainly exceed it.
Formula
Max Drawdown ($) = Highest Equity Peak − Lowest Equity Trough After That Peak
Max Drawdown (%) = (Highest Equity Peak − Lowest Equity Trough After That Peak) / Highest Equity Peak × 100
The trough must occur after the peak in time. You scan the entire equity curve and keep the largest such peak-to-trough decline as the maximum.
Worked example
Your account starts at $10,000, runs up to $12,000, then draws down to $9,000 before recovering.
Peak = $12,000 Trough = $9,000 Max Drawdown ($) = $12,000 − $9,000 = $3,000 Max Drawdown (%) = $3,000 / $12,000 × 100 = 25%
Even though the account is still above its starting balance, the strategy produced a 25% drawdown from peak — a serious figure that would breach most prop firm limits.
Why it matters
Prop firm rules, position sizing decisions, and emotional capacity to keep trading all hinge on Max Drawdown. A strategy with 30% historical max drawdown will at some point produce 40% or worse in live trading; size accordingly. The Trader+AI journal plots running drawdown alongside the equity curve so the worst stretch is always visible.
Common pitfalls
Max Drawdown measured on closed-trade equity hides intratrade pain — the curve looks smoother than it really was. Always measure on a mark-to-market equity series that includes open floating P&L. Also, historical max drawdown is a lower bound on future drawdown, never an upper bound.