What it means
Two strategies can finish with the same account value after very different paths, one growing steadily while another suffers a large decline before recovering. An equity curve makes those differences visible and helps explain the experience behind a headline return.
Define equity before drawing the chart, because an account-value curve normally includes cash and the current value of open positions net of relevant liabilities, while a closed-trade curve may record only completed trades and conceal unrealised losses or gains. The horizontal axis also matters.
A calendar-time chart shows how long money was exposed and how long recovery took, while a chart indexed by trade number describes the sequence of outcomes but can hide long gaps or several simultaneous positions. External cash flows can distort the picture, since adding money raises account value without creating profit and a withdrawal lowers it without proving a loss, so identify those movements or use a return-based series.
Costs should be explicit, because commissions, financing charges, spreads and other expenses can turn a promising gross curve into a weak net result. A backtest that omits realistic execution costs is not comparable with the value actually reported by a broker.
Drawdown measures a decline from a previous peak, and its depth and duration help distinguish ordinary fluctuations from a loss that would be difficult to tolerate or finance. The scale affects visual interpretation: a linear scale emphasises absolute changes in money, while a logarithmic scale emphasises proportional changes.
State the choice rather than comparing charts whose scales make similar results look different. A smooth chart is not automatically safe either, since infrequent valuations, illiquid holdings or omitted open positions can suppress visible fluctuations.
Strategy development introduces another concern, because a curve built after selecting the best settings from many trials reflects that selection process. Out-of-sample testing and transparent assumptions help assess whether the result depends on tuning to historical observations.
Academic trading-system projects illustrate equity curves alongside drawdown, commission effects and underlying-market comparisons, but a historical result is not a recommendation or a forecast. Benchmark comparisons require consistent dates and cash-flow treatment, because a strategy with less exposure, different leverage or different assets may not be fairly assessed against an unrelated market chart.
For a non-finance manager reviewing an investment proposal, request the net curve, starting capital, external flows and largest decline. Ask what data were actual and what were simulated, because the chart should make the risk easier to understand, not replace the evidence behind it.
In practice
Real-world examples.
Example
Two portfolios both rise from $100,000 to $110,000 without external flows. One never falls below $98,000; the other drops to $65,000 before recovering. Their identical ending gain conceals very different drawdown experiences.
Example
A trading account rises from $40,000 to $60,000 after its owner deposits $20,000. The account-value curve rises, but that movement alone shows no investment profit. The analyst records the deposit separately before evaluating returns.
Example
A backtest records profits only when positions close. An open position is currently losing $12,000, so the closed-trade curve overstates current account equity. The reviewer requests a mark-to-market curve including all positions.
Formula
Calculation
Drawdown = Current equity / Previous peak equity - 1
Gain needed to recover = Previous peak equity / Current equity - 1
Worked example. An account's peak is $120,000 and its value falls to $90,000.
- Drawdown = $90,000 / $120,000 - 1 = 0.75 - 1 = -25%.
- Gain needed to recover = $120,000 / $90,000 - 1 = 1.333 - 1 = 33.3%, which equals the $30,000 loss divided by the $90,000 now left.
- A deeper fall shows the asymmetry: from $100,000 to $50,000 is a -50% drawdown, and recovering requires $100,000 / $50,000 - 1 = 100%.
This is why the recovery percentage differs from the loss percentage, and why the depth of the worst drawdown matters as much as the final return.Case study
Seen in the real world.
Fictional case: A treasury team sees a strategy presentation with a rising closed-trade curve. Finance adds open-position values, financing costs and cash-flow labels. The revised chart reveals a prolonged drawdown that the original concealed, so management revises its risk limit before considering an allocation. The team then asks the presenter for the same chart on a calendar-time axis, with deposits and withdrawals marked and costs deducted.
The new curve rises more slowly, and the largest decline lasts far longer than the closed-trade chart suggested. Management sets a maximum drawdown it is willing to tolerate and decides the proposal fails that test as presented. The presenter returns with a revised strategy and a net-of-cost curve, and the committee reviews it on the same terms. The illustrative lesson is that the curve is a tool for asking better questions, not a certificate of quality.
Watch out
Common mistakes.
- Treating deposits as trading profits or withdrawals as investment losses.
- Comparing curves with different valuation, cost, leverage or time-axis assumptions.
- Assuming a smooth historical backtest guarantees low risk or future profitability.
Questions
People also ask.
Does an equity curve show only completed trades?
Not necessarily. A mark-to-market curve includes open positions; the calculation must be stated.
Can two equal final returns have different risks?
Yes. The depth and duration of losses along the way can differ greatly.
Does a deposit improve investment performance?
It raises account value, but it is an external flow rather than an investment return.
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