Drawdowns, Losing Streaks and Risk of Ruin

What you will learn

• How to calculate a drawdown and the gain needed to recover it.
• Why long losing streaks are normal, even with a positive expectancy.
• What "risk of ruin" means in practical terms.
• How daily and weekly loss limits and size reductions work.

Explanation

A drawdown is the fall from the highest account value (the peak) to a later low, in euros or percent. The maximum drawdown is the largest such fall in a period.

Recovery math: after a loss of d (as a decimal), you need a gain of d ÷ (1 − d) to return to the peak.

Losing streaks: with a 40% win rate, the loss rate is 60%. The chance that a specific run of 8 trades are all losers is 0.6⁸ ≈ 1.7%. That sounds rare. But a simple probability calculation shows that over 100 independent trades, the chance of seeing at least one streak of 8 or more losses is roughly 49%. Long streaks are part of normal results.

Risk of ruin is the probability of losing so much that you can no longer trade as planned. You define "ruin" yourself, for example a 30% drawdown. It rises sharply with risk per trade and falls with higher expectancy. You do not need an exact formula; the key point is that smaller risk per trade makes ruin much less likely.

Loss limits: a daily loss limit (for example 2R) and a weekly loss limit (for example 4R) stop trading for that period once reached. They protect you from emotional trading after losses.

Worked example

Hypothetical example: account €10,000. Fixed fractional sizing: each trade risks a fixed percentage of the current balance. Ten losses in a row, no gaps, fees excluded.

• 1% per trade: €10,000 × 0.99¹⁰ = €9,044 → drawdown about 9.6%, needs about 10.6% to recover.
• 2% per trade: €10,000 × 0.98¹⁰ = €8,171 → drawdown about 18.3%, needs about 22.4%.
• 5% per trade: €10,000 × 0.95¹⁰ = €5,987 → drawdown about 40.1%, needs about 67%.

Size-reduction rule (example): at a 5% drawdown (equity €9,500), halve risk from 1% to 0.5%. At 10% (equity €9,000), stop trading and review your journal before restarting. Return to full size only after recovering a defined part of the drawdown.

Common mistake

Practice activity

Account €8,000, fixed fractional risk 1.5% per trade. Calculate the account value after 6 losses in a row, the drawdown in percent, and the gain needed to recover.

Key takeaways

• Recovering from a drawdown needs a larger percentage gain than the loss.
• Long losing streaks happen even with a positive expectancy.
• Lower risk per trade sharply reduces the chance of a damaging drawdown.
• Use daily/weekly loss limits and reduce size during drawdowns.

Next step

The next lesson covers news and scheduled events, where gaps and slippage are most likely.