Understanding Drawdown

What You Will Learn

The three dimensions of drawdown: depth, duration, and frequency.
Why crypto drawdowns are fundamentally different from traditional markets.
How to design your drawdown tolerance before it happens.

The Core Idea

Returns are uncertain. Drawdowns are guaranteed.

Most traders obsess over how much they can make. A botter asks a different question: How deep can I sink and still continue?

This isn’t pessimism—it’s survival design. You don’t control when the market crashes. You control whether you’re still standing when it recovers.

Anatomy of a Drawdown

A drawdown measures the decline from a peak to a trough. But a single percentage doesn’t tell the whole story. You need to understand three dimensions:

Depth — How far you fall. BTC dropped 84% from its 2017 high to the 2018 bottom. It dropped 77% from 2021 to 2022. For altcoins, 90%+ drawdowns are routine, not exceptional.

Duration — How long until recovery. After the 2017 peak, BTC took nearly three years to reclaim its previous high. Many altcoins from that cycle never recovered at all.

Frequency — How often it happens. In crypto, a 20% drawdown is not a crisis—it’s a quarterly occurrence. Expecting smooth equity curves here is a recipe for emotional ruin.

The Asymmetry of Recovery

Here’s the math that every trader needs to internalize:

Drawdown	Recovery Needed
-10%	+11.1%
-25%	+33.3%
-50%	+100%
-75%	+300%
-90%	+900%

A 50% loss doesn’t mean you need a 50% gain to break even. You need to double your money just to get back to where you started.

This asymmetry is why altcoins that drop 90%+ rarely recover. A +900% return is not impossible, but it requires conditions that may never repeat.

The takeaway: avoiding deep drawdowns matters more than chasing high returns.

Leverage Amplifies Everything

Leverage doesn’t just multiply gains—it multiplies drawdowns.

With 3x leverage, a 33% market drop doesn’t leave you down 33%. It wipes you out completely. Liquidation at -100%.

It gets worse. When you’re holding a leveraged position through a drawdown, funding rates can drain your account further. During strong trends, annualized funding can exceed 50-100%. That’s a silent bleed on top of your paper loss.

Think of leverage not as a return multiplier, but as a drawdown amplifier. The question isn’t “how much more can I make?” It’s “can I survive the worst case at this leverage level?”

Designing Your Drawdown Tolerance

Don’t wait until you’re in a drawdown to decide how much you can handle. Design it beforehand:

Step 1: Define your maximum tolerable drawdown.

Pick a number you can endure without abandoning your strategy. Be honest. If 30% feels like your limit on paper, your real limit is probably 20%.

Step 2: Add a safety margin to backtested results.

If your backtest shows a maximum drawdown of 25%, assume real-world conditions will be worse. Multiply by 1.5x to 2x. Plan for a 37-50% drawdown.

Step 3: Size positions accordingly.

Work backwards from your drawdown tolerance to determine your position size. This connects directly to position sizing—risk percentage and drawdown are two sides of the same coin.

The key insight: start from acceptable drawdown, then derive your risk—not the other way around.

Common Failure Modes

Treating backtested MDD as the worst case. History shows the floor, not the ceiling. In 2022, LUNA/UST holders experienced a 99.99% drawdown that no backtest could have predicted.
Changing strategy during a drawdown. This locks in losses at the worst possible time and often means missing the recovery. If your strategy was sound before the drawdown, it’s still sound during it.
Confusing paper losses with real ones. A 30% drawdown on a spreadsheet feels very different from watching 30% of your actual money disappear. Most people overestimate their emotional tolerance.
Ignoring correlation. Holding BTC, ETH, and SOL isn’t diversification—it’s concentration. In a market crash, correlated assets fall together. Your “three positions” are really one large bet.