The first number people read on a strategy result is almost always the annual return. That number says what the strategy earned. What it does not say is whether you would still be running it, and the number that does say so sits a little further down the list: maximum drawdown.
What maximum drawdown measures
The percentage a portfolio loses from a peak down to its deepest trough afterwards. An account that starts at a hundred thousand, rises to a hundred and thirty and falls to ninety has a maximum drawdown of thirty-one per cent; the calculation runs from the highest point it reached, not from where it started.
That distinction matters. A strategy with a positive total return can have halved along the way, and during that stretch nobody keeps running it.
Why the arithmetic is asymmetric
An account that falls fifty per cent needs a hundred per cent gain to get back to where it was. An account that falls twenty per cent needs twenty-five.
The asymmetry gets worse quickly as the drawdown deepens, and it changes how strategies compare. A strategy earning thirty per cent a year with a sixty per cent drawdown can be mathematically better than one earning twelve per cent with a fifteen per cent drawdown. Whether it is usable is a separate question.
Duration wears people down more than depth
Maximum drawdown gives you one number, and two more pieces of information exist that a result report usually omits.
Length of the drawdown. How many days ran from the peak to the trough.
Time to recover. How many days it took to get from the trough back to the old peak.
A twenty per cent drawdown that recovers in three weeks is survivable. The same twenty per cent stretched over fourteen months and most people shut the strategy down somewhere in the middle of it, and a strategy that has been shut down never produces the rest of its return.
Backtests understate drawdown
In a test looking backwards, you know how the drawdown ends. Live, you do not, and that difference cannot be measured.
Beyond it there are two technical reasons. The first is cost: with no commission or slippage applied, the real drawdown runs deeper than the test output. The second is sample: the worst stretch a two-year test happened to see does not have to be the worst stretch of the next two years.
There is a practical correction. Multiply the maximum drawdown the test reports by 1.5 and make the decision on that number.
How it turns into a decision
Set a threshold first: at what percentage down do you stop the strategy? Write that number before any drawdown happens.
Then size the position against that threshold. If you want to run a strategy that showed a forty per cent drawdown in testing under a twenty per cent threshold, halving the capital you give it is the simplest way there.
Any strategy started without a written threshold gets re-evaluated emotionally at the first serious drawdown. The decision made in that moment is not a good one.
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