Trading Drawdowns: What You Need to Know About Account Underwater Periods

When discussing trading, understanding what is drawdown in trading becomes one of the first critical lessons every trader must learn. A drawdown isn’t a sign of failure—it’s simply the gap between your account’s peak value and its current low point during a losing streak. The harsh reality? Your account will spend a significant portion of its lifetime in drawdown, even during generally profitable periods.

The Natural Reality: Drawdowns Are Inevitable

Let’s be direct: trading involves losses. This isn’t pessimism—it’s fact. Even traders with a 50% win rate will experience clusters of consecutive losing trades, just as they’ll experience winning streaks. It’s probability at work, similar to flipping a coin multiple times.

What separates profitable traders from struggling ones isn’t avoiding drawdowns entirely—it’s how they respond when one occurs. A trader might generate consistent profits across a year but still endure multiple 20-30% underwater periods along the way. The key is recognizing which drawdowns are manageable and which signal deeper problems.

Two Drawdown Categories: Know the Difference

Normal Drawdowns: Part of the Process

These are the everyday realities of trading. They stem from market volatility, probabilities, and the natural ebb and flow of price action. If you’re following your trading plan, controlling losses properly, and the drawdown isn’t extreme, this is just business as usual.

A trader attempting breakout trades during a range-bound market might face temporary losses—this is normal. Market conditions simply don’t align with the strategy at that moment. These drawdowns typically recover quickly once conditions shift or the trader acknowledges the mismatch and adjusts approach.

Problematic Drawdowns: Warning Signs

These are different. Problematic drawdowns result from behavioral breakdowns—over-trading, poor position sizing, abandoning risk management rules, or emotional decision-making. Losses accumulate faster than normal, and both financial and psychological capital deteriorate rapidly.

The distinction matters because the treatment differs. Normal drawdowns require patience and adherence to plan. Problematic ones demand immediate intervention.

Handling Normal Drawdowns: Stay the Course

When experiencing a typical drawdown while following your trading plan, the approach is straightforward:

First, assess reality. Are market conditions actually suitable for your strategy right now? Sometimes a drawdown signals that you should sit on the sidelines rather than force trades. A range-bound market favors different setups than trending conditions. Acknowledging this mismatch is self-awareness in action.

Second, check your execution. Review recent trades against your documented plan. Are you following entries and exits precisely? Are you respecting position size limits? Most traders discover that minor execution errors—slightly oversized positions, marginal trade setups—compound into drawdowns.

Third, reduce exposure. The old saying “when in doubt, get out” applies perfectly. If you’re uncomfortable with current trading conditions, cut your position size. There’s no shame in trading 50% smaller during uncertain periods. This alone can halt a deteriorating drawdown.

Finally, maintain records. Your trade journal becomes invaluable here. Document what triggered each loss, market conditions, your mental state, and whether you followed your checklist. Over-trading and poor risk management consistently emerge as the primary culprits for subpar results, and your journal will confirm this.

Handling Problematic Drawdowns: Emergency Protocol

When losses feel out of control and your account is experiencing severe deterioration, different medicine is required.

Step one: Stop trading immediately. Not reduced trading—complete cessation for several days or longer. Close existing positions. This isn’t cowardice; it’s emergency damage control. Your first objective is stopping the bleeding, not recovering losses.

This pause serves a psychological purpose too. Stepping away provides mental relief and prevents compounding errors through desperation trading. Most traders who implement this practice later become advocates for it, recognizing the discipline required to walk away when emotions run highest.

Step two: Conduct a thorough diagnosis. After you’ve recovered mentally, review your trade history, journal entries, and trading records. Identify the exact behaviors that triggered the problematic drawdown. Most commonly you’ll find: positions sized too large relative to account size, excessive trading frequency, entry into low-probability setups, or inadequate risk-reward ratios.

Step three: Resume with minimal size. Once you’ve identified problems and implemented fixes, return to trading—but at 50% maximum position size or less. The goal isn’t recovering all losses immediately. The goal is rebuilding confidence and reestablishing positive momentum. Small wins during this recovery phase prove your fixes work.

Prevention: Building Systems That Work

The most effective approach combines prevention with crisis management.

Implement a physical or mental checklist before each trade. This simple tool keeps you aligned with your documented game plan, filtering out the impulsive or low-quality setups that typically precede problematic drawdowns.

Maintain strict risk management parameters. Tighter position sizing means losses accumulate slowly even during adverse periods, providing more time to recognize and correct course.

Recognize external stressors. Personal life challenges—relationship issues, health concerns, financial pressure—reduce your mental clarity and increase trading mistakes. If you’re dealing with significant personal issues, acknowledge that the market isn’t therapeutic. Resolve those matters first, then return to trading fresh.

Remember: the market will always exist. There’s no premium for trading while distracted or emotionally compromised.

Final Perspective

Understanding what is drawdown in trading—both conceptually and emotionally—separates traders who eventually find success from those who abandon the profession. Drawdowns aren’t failures. They’re navigation points. Your response to them determines whether you grow as a trader or repeat the same mistakes perpetually.