Your backtest report shows a profit factor of 2.1, but when you look at the equity curve, that dip in the middle almost wiped out your account. Many traders know this feeling well — the numbers look great, but the process is brutal.
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A high profit factor combined with a big drawdown means your ability to make money is fine, but the way you make money has a serious flaw. Today we won't beat around the bush — let's go straight to finding the culprit from your trading journal.
Step 1: Filter Out All Trades During the Maximum Drawdown Period
[What to do]: Find the period when your account dropped the hardest, and pull out all the trades from that period separately.
[How to do it]: Open your trading journal and find the lowest point on the equity curve. Copy all trades from the previous high down to that low point into a new spreadsheet.
Common failure reason: Many people only look at the "maximum drawdown percentage" number and never examine what happened during the drawdown. As a result, they only know it hurt, but not where they got stabbed.
[Completion standard]: You have two tables — one is "drawdown period trade records" and the other is "normal period trade records."
Step 2: Compare the Two Groups of Trades and Find the Differences
[What to do]: Compare trades from the drawdown period with trades from the normal period item by item, and see which dimensions are clearly abnormal during the drawdown.
[How to do it]: Compare the following dimensions — not by feeling, but by pulling actual data:
| Comparison Dimension | Normal Period | Drawdown Period | Difference Magnitude |
|---|---|---|---|
| Average holding time | Calculate it | Calculate it | Are you holding longer during drawdowns? |
| Average position size | Calculate it | Calculate it | Are you trading heavier during drawdowns? |
| Profit/loss ratio (avg win / avg loss) | Calculate it | Calculate it | Did the profit/loss ratio collapse during drawdowns? |
| Win rate | Calculate it | Calculate it | Did you have a losing streak during drawdowns? |
After this step, you will have a general direction:
- If the average position size is clearly larger during the drawdown period → the problem is in position sizing. You are placing heavier bets when you are losing.
- If the holding time is clearly longer during the drawdown period → the problem is in stop loss discipline. You are holding onto losing trades.
- If the profit/loss ratio collapsed but position size was normal → the problem may be in signal quality or changing market conditions.
Step 3: Identify the "Toxic Trades" and Check Profit Concentration
[What to do]: Strategies with highly concentrated profits tend to have especially large drawdowns. Check how much of your total profit comes from the top 5% of your biggest winning trades.
[How to do it]: Sort all your winning trades by amount from largest to smallest. Calculate what percentage of total profit comes from the top 5% of winning trades.
- If this percentage exceeds 50%, your strategy heavily depends on a few large wins. Once those big trades fail to appear, your account will experience severe drawdowns.
Here is a real strategy example: total profit was $390,000, but the maximum drawdown was $340,000 — almost equal to the entire profit. The reason was that a single ETH long trade contributed 82% of the total profit, while the other trades were basically breaking even or losing.
[Completion standard]: You can clearly state whether your drawdown is caused by "heavy positions and refusing to cut losses" or by "the strategy concentrating bets on a few opportunities." The former requires fixing discipline; the latter requires considering diversification.
Risk reminder: Profit factor and drawdown must be examined together. A strategy with a profit factor of 2.0 but a 30% maximum drawdown versus a strategy with a profit factor of 1.5 but a 10% maximum drawdown — the latter will likely let you sleep better in live trading. This is especially true when you want to add positions — when drawdowns get large, your position size will be forced to shrink, and the compounding effect will be directly discounted.
Step 4: Break Down the Drawdown by Signal Type
[What to do]: Are the losing trades during the drawdown period concentrated in a particular type of signal?
[How to do it]: Add a column called "signal type" to your journal (for example, breakout, pullback, moving average crossover, news-based). Then filter out the losing trades during the drawdown period, group them by signal type, and see which type accounts for the largest share of losses.
If you find that 80% of the losses during the drawdown period came from "breakout signals," it means your breakout strategy is especially fragile when the market shifts — either optimize the entry conditions for this signal, or pause using it when the market enters a specific cycle.
FAQ
Q: Did my drawdown decline slowly, or did it spike down suddenly like a needle?
A: A slow decline means your strategy is continuously failing, possibly because the market environment has changed. A sudden spike means you encountered extreme market conditions, and your stop loss settings may be too tight. The responses to these two situations are completely different — check your candlestick chart to confirm the pattern.
Q: How high does a profit factor need to be before it becomes "suspiciously high"?
A: In live trading, be cautious if the profit factor exceeds 2.5. In backtesting, a profit factor above 3.0 is basically the result of over-optimization, and in live trading it will most likely be discounted to below 1.5.
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Next Action
Open your journal and find the largest drawdown period in your account history. Filter out all the trades from that period and compare them using the table in Step 2.
After identifying the most abnormal dimension — for the next month, only change that one variable. If position size was too heavy, fix your position size. If you were holding onto losers, force yourself to set stop losses. Don't change three things at once — you will never know which one made the difference.
