drawdown-playbook

> **Skill:** Drawdown Playbook | **Domain:** trading/risk-and-portfolio | **Category:** risk | **Level:** advanced > **Tags:** `drawdown`, `recovery`, `equity-curve`, `max-dd`, `protocols` # Drawdown Playbook ## 1. Drawdown Taxonomy ### Types | Type | Definition | Typical Cause | |------|-----------|---------------| | **Strategy DD** | Expected drawdown within strategy parameters | Normal variance | | **Behavioral DD** | Drawdown from rule violations | Revenge trading, FOMO | | **Regime DD** | Drawdown from regime change | Strategy-regime mismatch | | **Black Swan DD** | Drawdown from extreme events | Flash crash, gap, liquidity vacuum | ### Measurement ``` Max Drawdown (MDD): MDD = (Peak - Trough) / Peak × 100 Average Drawdown: Avg of all drawdown periods in lookback window Drawdown Duration: Time from peak to recovery (not just to trough) Ulcer Index: UI = sqrt(mean(DD²)) — penalizes deep AND long drawdowns ``` ## 2. Drawdown Thresholds & Responses ### Tiered Response Protocol ``` LEVEL 1: CAUTION (DD = 3-5% of account) ├── Review: Check if within strategy expected DD ├── Action: Reduce position size by 25% ├── Monitor: Tighten review frequency to per-trade └── Journal: Document what's happening in market LEVEL 2: WARNING (DD = 5-10% of account) ├── Review: Full strategy audit — is this regime change? ├── Action: Reduce position size by 50% ├── Restrict: No new strategy experiments ├── Require: Every trade needs written thesis before entry └── Timeline: If no recovery in 10 sessions, escalate LEVEL 3: CRITICAL (DD = 10-15% of account) ├── Action: Reduce to 1 instrument, 1 strategy, minimum size ├── Pause: No trading for 24-48 hours minimum ├── Audit: Full performance review with data │ ├── Win rate vs historical │ ├── Average R vs historical │ ├── Are losses from stops or blowups? │ └── Regime classification check ├── Require: Paper trade for 5 sessions before resuming └── Consider: Is the strategy broken or am I broken? LEVEL 4: EMERGENCY (DD > 15% of account) ├── Action: STOP TRADING. Full stop. ├── Close: All open positions at market ├── Duration: Minimum 1 week away from screens ├── Requirement: Complete written post-mortem before resuming ├── Review: Account sizing — is total capital at risk appropriate? └── Return: Restart at LEVEL 1 position sizes for 20+ trades ``` ## 3. Equity Curve Analysis ### Health Indicators ``` HEALTHY EQUITY CURVE: ✓ Drawdowns are shallow relative to advances ✓ Recovery time < 2× drawdown duration ✓ New equity highs every 20-40 trades ✓ Ulcer Index < 5% ✓ Consistent slope (not spike-dependent) DETERIORATING EQUITY CURVE: ✗ Drawdowns deepening over time ✗ Time between new highs increasing ✗ Equity curve flattening (winners shrinking) ✗ Large gap between gross and net P&L (overtrading) ``` ### Rolling Performance Windows ```python def equity_health_check(trades: list[Trade], window: int = 50) -> dict: """Run on last N trades to detect deterioration early.""" recent = trades[-window:] metrics = { 'win_rate': len([t for t in recent if t.pnl > 0]) / len(recent), 'avg_r': mean([t.r_multiple for t in recent]), 'max_dd_pct': max_drawdown(recent), 'profit_factor': sum(wins) / abs(sum(losses)), 'expectancy': win_rate * avg_win - (1 - win_rate) * avg_loss, 'sqn': (avg_r / std_r) * sqrt(len(recent)), # System Quality Number } # Compare to full history baseline = compute_metrics(trades) alerts = [] if metrics['win_rate'] < baseline['win_rate'] * 0.85: alerts.append('WIN_RATE_DEGRADATION') if metrics['avg_r'] < baseline['avg_r'] * 0.75: alerts.append('R_MULTIPLE_COMPRESSION') if metrics['max_dd_pct'] > baseline['max_dd_pct'] * 1.5: alerts.append('DRAWDOWN_EXPANSION') if metrics['sqn'] < 1.6: alerts.append('SYSTEM_QUALITY_LOW') return {'metrics': metrics, 'alerts': alerts} ``` ## 4. Recovery Protocols ### Mathematical Reality of Recovery ``` Loss Required Gain to Recover ───── ──────────────────────── 5% → 5.3% 10% → 11.1% 15% → 17.6% 20% → 25.0% 25% → 33.3% 30% → 42.9% 50% → 100% ← Point of no practical return ``` ### Recovery Rules ``` 1. Never try to recover fast. Increasing size during drawdown accelerates ruin. 2. Recovery position size = Normal size × (1 - DD%/MaxAllowableDD%) 3. Track recovery separately. When equity returns to 95% of peak, you're "recovered." 4. Time-based recovery. After emergency stop, require N profitable paper trades before live. ``` ## 5. Pre-Drawdown Preparation ### Account Structure ``` Total Capital: $X ├── Trading Account: 60-70% of X │ ├── Active margin: ≤50% of trading account │ └── Reserve: ≥50% as buffer ├── Opportunity Reserve: 20-30% of X │ └── Deploy only in high-conviction setups after drawdown recovery └── Emergency Fund: 10% of X (NEVER trade this) ``` ### Pre-Commitment Device ``` Write this BEFORE you start trading, sign it, review monthly: My maximum account drawdown is ____% At ____% DD I reduce size by ____% At ____% DD I stop trading for ____ days I will not increase size during drawdown I will not add funds to cover drawdown (throwing good money after bad) ``` ## 6. Drawdown Journaling Template ```markdown ## Drawdown Event: [DATE] **Current DD:** ___% | **Level:** 1/2/3/4 **Duration:** ___ trading days since peak **Peak Equity:** $___ | **Current Equity:** $___ ### What happened? - [] Normal strategy variance - [] Regime change - [] Rule violation - [] Unexpected event - [] Overtrading - [] Position sizing error ### My mental state: - [] Calm, following protocol - [] Frustrated but controlled - [] Anxious, wanting to make it back - [] Tilted / revenge trading impulse ### Actions taken: 1. ___ 2. ___ 3. ___ ### Review date: [DATE + 3 days] ``` --- ## Related Skills - [Risk And Portfolio](risk-and-portfolio.md) - [Correlation Crisis](correlation-crisis.md) - [Risk Of Ruin](risk-of-ruin.md) - [Real-Time Risk Monitor](real-time-risk-monitor.md)