Risk and Drawdowns
Why equity declines are an unavoidable structural reality of market participation—and why automation alone cannot solve them.
01. Defining the Drawdown
A drawdown represents the peak-to-trough decline during a specific period for an investment or trading account. It is the distance between a “new high” in equity and the subsequent low before recovery.
Drawdowns are not anomalies; they are the natural breathing of a trading system. Even the most successful strategies in history spend the majority of their time in some state of drawdown.
02. The Recovery Math Canvas
The danger of a drawdown isn’t just the loss—it’s the asymmetric math required to get back to even. The deeper the hole, the steeper the climb.
| Drawdown (%) | Recovery Needed (%) |
|---|---|
| 10% | 11.1% |
| 25% | 33.3% |
| 50% | 100.0% |
03. Automation vs. Risk Adaptation
A common misconception is that automation “fixes” drawdowns. In reality, automation is a multiplier of strategy.
“If your strategy is mathematically prone to a 40% drawdown, an automated system will simply execute that 40% drawdown with perfect, unblinking consistency.”
Automation protects against emotional errors (like widening a stop-loss), but it cannot protect against a strategy that is poorly aligned with current market volatility.
04. User Responsibility
The ultimate safeguard is not the code, but the user-defined parameters. Managing drawdowns requires active oversight of:
- Strict position sizing relative to total equity.
- Hard daily or weekly loss limits.
- Deleveraging during high-volatility regimes.