What Is Drawdown in Prop Trading?
Learn what drawdown means in prop trading, the 5 main types, how they work, and simple strategies to avoid breaches and stay funded successfully.
If you’re trading with a funded account or trying to pass a prop firm challenge, understanding one word could decide whether you stay funded—or lose your account: drawdown.
A drawdown is not just a technical term. It’s the maximum amount you’re allowed to lose before your account is closed. It shows how far your account has dropped during losses. It’s also the number one rule you need to respect to keep your funding.
Different proprietary trading firms (prop firms) use different types of drawdown rules. Some are flexible, others are very strict. This guide will explain the most common types, how each one works, how to calculate your limits, and what you can do to stay safe while trading.
Let’s break it down in simple terms.
What Is a Drawdown?
In trading, a drawdown is the amount your account goes down from its highest point (the peak) to the lowest point (after losses).
It’s usually shown as a percentage of your account.
Example:
If your trading account starts at $100,000 and drops to $95,000, your drawdown is $5,000 or 5%.
Drawdowns help traders and firms understand how risky your trading strategy is. If your drawdown is too large, it may mean your trading is too aggressive—or that your plan needs adjustment.
Why Drawdowns Matter in Prop Trading
Prop firms want to give money to traders, but they need to manage risk. That’s why they set drawdown rules. These rules protect their capital and help you learn risk discipline.
Here’s why drawdowns are important for funded traders:
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They set your maximum risk limit
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They protect you from blowing up your account
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They teach risk management and discipline
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They help you avoid emotional trading
If you break a drawdown rule—even for a second—your account is usually closed. It doesn’t matter if you recover later. That’s why you must understand your drawdown limit and stay well within it.
Two Key Terms to Know
Before we look at the different types of drawdowns, here are two terms you need to know:
1. Drawdown High Point
This is the highest your account has reached. Depending on the drawdown type, it could be your balance or equity. The drawdown is calculated from this peak value.
2. Stop-Out Level
This is the lowest point your account is allowed to drop. If your balance or equity falls below this number, your account is breached.
Types of Drawdown in Prop Trading
There are 5 main types of drawdown rules used by prop firms. Each one works differently and affects your risk in unique ways.
1. Balance-Based Drawdown
A balance-based drawdown is calculated using only your closed trades. This means it ignores floating (open) profits and losses.
How it works:
Let’s say you start with $100,000. The firm allows a maximum drawdown of 5%.
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Your stop-out = $100,000 – 5% = $95,000
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Only closed trades are counted toward that limit.
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If your balance falls below $95,000 due to closed losses, you’ve broken the rule.
Pros:
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Safer for swing traders
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Floating losses don’t stop you out
Cons:
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Some firms still monitor equity, so be careful
2. Equity-Based Drawdown
An equity-based drawdown includes both closed trades and open trades. Your equity is your balance plus or minus unrealized profit or loss.
This rule is stricter because it uses the highest equity point during the trading day to calculate the drawdown.
Example:
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Start: $100,000
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Your open trades push equity to $105,000
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Drawdown limit = 5% of $105,000 = $5,250
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Stop-out level = $105,000 – $5,250 = $99,750
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If your equity drops below $99,750—even if trades aren’t closed—you’re out
Pros:
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Real-time risk control
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Good for short-term traders
Cons:
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Very sensitive to floating losses
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Not good for holding trades long-term
3. Static (Fixed or Absolute) Drawdown
A static drawdown sets a fixed maximum loss based on your starting balance. It does not change, even if your account grows.
Example:
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Start: $100,000
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Drawdown limit = 10%
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Stop-out = $100,000 – 10% = $90,000
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If your balance or equity drops to $90,000, you fail
Pros:
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Very clear rules
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Good for tracking risk
Cons:
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Doesn’t reward account growth
4. Trailing (Relative or Smart) Drawdown
A trailing drawdown follows your highest balance. It “trails” behind it by a fixed amount. As you make more money, your stop-out level moves up too.
Example:
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Start: $100,000
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Account grows to $108,000
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Trailing drawdown = 10% of initial balance = $10,000
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New stop-out = $108,000 – $10,000 = $98,000
If your balance falls below $98,000, the account is breached—even though you made money before.
Pros:
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Locks in profits
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Helps protect growth
Cons:
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Stops can feel tighter over time
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More stress for traders with high volatility
5. Max Daily Drawdown
A daily drawdown rule sets a limit for how much you can lose in one day.
Example:
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Start of day balance: $106,000
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Daily limit: 5% = $5,300
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Stop-out level = $106,000 – $5,300 = $100,700
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If you hit that, you’re stopped out for the day or fail the challenge
Pros:
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Protects against large one-day losses
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Builds trading discipline
Cons:
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Can be tricky for high-risk strategies
Summary Chart: Drawdown Types
| Drawdown Type | Based On | Changes Over Time? | Counts Open Trades? | Typical Use |
|---|---|---|---|---|
| Balance-Based | Closed trades | No | No | Swing/long trades |
| Equity-Based | Equity (with floating) | Yes | Yes | Intraday/strict firms |
| Static Drawdown | Starting balance | No | Sometimes | Easy tracking |
| Trailing Drawdown | Peak balance | Yes | Yes | Growth-focused rules |
| Daily Drawdown | Start of day balance | Daily | Yes | Daily safety check |
How to Avoid Drawdown Violations
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Know Your Rules
Always read your prop firm’s drawdown policy. Some use hidden equity checks even with balance-based drawdowns. -
Use Safe Risk Per Trade
Limit each trade to 1% or less of your account size. -
Avoid Overtrading
Take 2–3 good trades a day. Don’t keep trading after hitting your limit. -
Track Both Balance and Equity
Even if only your balance matters, watch your equity too. Floating losses can lead to surprise stop-outs. -
Set Custom Daily Limits
If your firm allows 5% loss, stop yourself at 2.5%. This adds a buffer. -
Walk Away on Bad Days
After 2–3 losses, stop trading. Don’t fight the market.
FAQs About Drawdowns
Q: Can I pass a challenge if I go below the drawdown but then recover?
A: No. Most firms treat a breach as final, even if you later make the money back.
Q: What if I withdraw profits from a funded account? Does the drawdown limit reset?
A: It depends on the firm. Some reset based on your new balance, others keep the original value.
Q: Do floating losses matter with balance-based drawdown?
A: Often, yes. If your equity drops too low—even with open trades—your account could still be stopped out.
Final Thoughts: Mastering Drawdown Management
If you want to become a professional trader with a funded account, you must master drawdown awareness and control.
Here’s what successful traders do:
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Understand the rules fully
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Keep trades small and controlled
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Protect their equity at all times
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Treat drawdowns as part of the plan—not as a surprise
Managing drawdowns is not just about numbers. It’s about discipline, consistency, and smart decision-making.
If you respect the rules and control your risk, staying funded becomes much easier—and profitable.
