Trailing Drawdown Explained: Formula, Examples & Prop Firm Rules

Key Highlights

A trailing drawdown can help in promoting better risk management, but it requires that the trader have a good understanding of its rules and psychological impact. In a nutshell:

• The trailing drawdown limit adjusts with every profit recorded
• It locks in profits, thus encouraging disciplined trading
• There are two popular types of trailing drawdowns: Intraday and end-of-day
• Your limit will remain fixed even if the balance reduces at a later date

Trailing Drawdown

A trailing drawdown is a moving loss limit that helps safeguard trading profits as the account grows. And unlike the case with a fixed drawdown, a trailing drawdown will continue to adjust upwards every time the funded account attains a new peak. 

But while profits will cause the limit to move upwards, please be advised that the same doesn’t happen with losses. Prop firms use these limits to help encourage discipline among their traders. They do this by locking in the profits, thus forcing you to adopt a more cautious approach to trading.

Besides encouraging trading discipline, a trailing drawdown also helps prop firms manage risk, while rewarding the traders who have shown consistent growth. Read on to learn more about what trailing drawdowns are and how they work. 

What Is Trailing Drawdown?

A trailing drawdown is a type of drawdown pegged to the positive performance of your funded account. The implication here is that any increase in profits will lead to an increase in the trailing drawdown limit. 

Let me use an example to explain this:

If you’re trading with a $50,000 funded account, the trailing drawdown will be $48,000. Let’s say that you manage to make a profit of $100 on the first day of trading.

The profit made will have increased the balance to a new high of $50,100. Due to this increase, the trailing drawdown will also increase by the same margin to become $48,100.

I think it’s important to note that this increase will continue until the trailing drawdown hits the account’s opening balance, which stood at $50,000. 

Once you reach this level, the trailing drawdown will cease increasing. 

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Why Do Prop Firms Use Trailing Drawdown?

Prop firms use trailing drawdown to encourage disciplined risk management and protect capital. By increasing the drawdown threshold as profits grow, firms can lock in gains while ensuring traders avoid excessive risk-taking.

This approach rewards consistency and helps prevent traders from giving back large portions of their profits.

Trailing Drawdown Formula

New Drawdown Limit =
Highest Account Equity
−
Maximum Drawdown Allowance

Example

Different Types of Trailing Drawdown

Trailing drawdowns help limit trading losses by moving the account’s maximum loss threshold upward as your profits increase. The primary types of drawdowns are:

Intraday Trailing Drawdown

Intraday trailing drawdown adjusts the drawdown threshold in real time as account equity increases. Because unrealized profits are included in the calculation, the drawdown limit can move throughout the trading day.

This makes intraday trailing drawdown more restrictive than end-of-day trailing drawdown and requires traders to monitor risk closely.

Key characteristics include:

• Updates continuously during market hours
• Includes unrealized profits
• More restrictive than end-of-day trailing drawdown
• Common among futures prop firms

For a deeper explanation, examples, and trading implications, read our guide on Intraday Trailing Drawdown.

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End of Day Trailing Drawdown

End-of-day trailing drawdown updates the drawdown limit after the trading day closes rather than in real time.

This model is generally more flexible than intraday trailing drawdown because unrealized profits and temporary intraday fluctuations do not immediately affect the drawdown threshold.

Learn more in our complete guide to End-of-Day Trailing Drawdown.

Static Drawdown

Unlike trailing drawdown, a static drawdown remains fixed and does not move upward as profits increase. The maximum loss limit stays the same regardless of account performance.

Key characteristics:

• Fixed loss limit

• Does not trail profits

• Easier to manage

• Popular among swing traders

For a complete explanation, examples, and comparisons, read our guide on Static Drawdown.For a full explanation, examples, and comparisons, read our guide on Static Drawdown.

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Types of Drawdown at a Glance

Trailing Drawdown vs Static Drawdown

Common Drawdown Calculation Mistakes

It’s not uncommon for you to encounter an issue when trying to calculate the trailing drawdown. Some of the mistakes you need to be on the lookout for include:

• Overlooking the Locking Mechanisms: Some prop firms will lock the trailing drawdown once your profits have reached a certain threshold. Read the terms and conditions from the prop firm to make sure you understand the locking mechanism, as this can impact your risk management plan .
• Misunderstanding Open Positions: The intraday trailing drawdown will normally include unrealized losses or gains from your open trade positions. Therefore, choosing to only focus on the closed trades will cause you to arrive at incorrect thresholds. 
• Combining Calculation Methods: A prop firm can either use intraday or EOD methods, and not both. Combining both methods in your calculations can lead to unwanted errors and confusion. 

Advantages of Trailing Drawdown

• Encourages disciplined trading
• Protects accumulated profits
• Rewards consistent account growth
• Helps prop firms manage risk

Disadvantages of Trailing Drawdown

• Can feel restrictive
• May penalize aggressive traders
• Requires close monitoring
• Different firms use different rules

Conclusion

The trailing drawdown can best be described as a flexible risk management tool that helps in promoting disciplined trading habits while safeguarding capital. How this drawdown is calculated will differ depending on the prop firm providing it and the type of account being used. For example, the end-of-day trailing drawdown will adjust when the market closes, while the intraday trailing drawdown will adjust in real time as you continue to trade. On the same breadth, there are firms that will halt the drawdown mechanism after you have attained your profit targets. Others, on the other hand, will continue indefinitely for as long as you’re trading. Understanding the differences between these types of drawdowns is vital because exceeding the limits set by the prop company will lead to account termination. At Audacity Capital , we have clear drawdown rules in place to make sure that your trading strategy will not be compromised. 

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