The Drawdown Derisking Ladder

A drawdown ladder is a schedule, agreed before any losses happen, that says exactly how much size gets cut at each stage of a losing stretch. Down 3% of allocated capital, cut risk by a quarter. Down 6%, cut it in half. Down 10%, stop trading new ideas and bring in a risk manager. The numbers vary by desk, but the principle is the same everywhere: the size of the position is a function of a rule set in advance, not a judgment call made in the middle of the losses themselves.

Why this can't be a judgment call in the moment

A trader who is down 8% for the month is, at that exact moment, the worst-positioned person on the desk to decide how much risk they should be running. They're likely to do one of two things, both bad: cut everything to zero out of fear, right before the strategy's edge reasserts itself, or double down to "trade back" the loss, right when discipline matters most. Neither instinct is really about the market — both are about how it feels to be down money. A ladder set when the trader was calm and thinking clearly takes that decision away from the version of them that's currently under stress.

An example ladder in action

A trader manages $5m of capital with the following pre-agreed schedule.

Drawdown from high-water mark	Action
0% – 3%	Full size, normal trading
3% – 6%	Cut position sizes by 25%; no new strategies
6% – 10%	Cut position sizes by 50%; existing book only, no adds
10%+	Flat by end of day; conversation with head of risk before resuming

The trader starts the month flat and by the second week is down 4%. Sizes across the book automatically shrink by a quarter — not because any single trade looks worse than before, but because the ladder says so at this drawdown level. The trader doesn't get a vote on whether this particular losing stretch "feels different" from a normal one; every losing stretch feels different from the inside, which is exactly why the rule exists. Two weeks later, the drawdown deepens to 7%. Sizes are cut again, to half of normal. By month end the strategy has recovered to a 2% drawdown, sizes go back to full, and the whole episode is reviewed afterward with a clear head rather than argued about while it was happening.

Getting back to full size

The ladder should specify the way back up as clearly as the way down. A common mistake is derisking mechanically on the way down but leaving the return to full size as a subjective call — which quietly reintroduces the same bias the ladder was built to remove, just in the other direction, as a trader who's clawed back losses argues they've "proven it" and should be trusted with size again immediately. A cleaner rule ties re-risking to the same kind of objective threshold: back to 50% size once the drawdown is under 5%, back to full once it's under 2%, regardless of how confident anyone feels in between.

Why this is different from a stop

A stop closes a single position when a specific price is hit. A drawdown ladder governs the size of the whole book based on cumulative results across many positions and doesn't care which individual trades caused the loss. A trader can honour every stop perfectly and still trip the ladder, simply because a string of individually well-managed losing trades adds up — and the ladder's job is to make sure that string doesn't compound into something much larger before anyone steps in.