What Risk and Drawdown Profiles Should You Expect for Each Strategy?

Understanding how different trading strategies behave under stress is one of the most important parts of building a reliable algorithmic portfolio. Every strategy generates returns in its own way, but more importantly, every strategy bleeds in a different way. Drawdowns, volatility, and tail-risk signatures vary widely across trend-following, mean-reversion, option selling, scalping, intraday models, and hybrids. If you know what to expect, you avoid reacting emotionally when a strategy behaves exactly as it is designed to.

Most retail traders evaluate strategies only on CAGR and win rate. But professionals judge systems by how they decline, how long they stay underwater, and how deeply they can draw down during different market regimes. This blog outlines the expected risk and drawdown profiles for the most common strategy classes so you can size them properly and set realistic expectations before deploying.

Trend-Following Strategies: High Volatility, Deep Drawdowns, Strong Right-Tail Returns

Trend-followers thrive in directional markets and struggle in choppy ones. Their return curves are uneven but powerful when markets move. Because they cut losses fast and let winners run, their drawdowns often come from repeated whipsaws.

Expected risk profile:

• Equity curves show long flat periods followed by explosive runs.
  
  
• Volatility of returns is higher than buy-and-hold during sideways regimes.
  
  
• Drawdowns of 20–35 percent are common even for robust systems.
  
  
• Maximum drawdown duration can last several months depending on trend cycles.
  
  
• Win rate is often low (30–45 percent), requiring psychological discipline.
  
  

Why drawdowns occur:
Trend-followers get chopped during sideways phases and take many small losses while waiting for a trend to emerge.

Who it suits:
Traders comfortable with larger but meaningful drawdowns and long periods of modest performance.

Mean-Reversion Strategies: Smooth Returns, Sharp Tail-Risk

Mean-reversion systems aim to catch short-term price extremes and revert to the mean. Their edges are small and frequent, which makes their return curves smoother than trend systems, but also exposes them to sudden failures.

Expected risk profile:

• Small, frequent profits with occasional large losses.
  
  
• Win rates above 60–75 percent, but poor payoff ratio.
  
  
• Drawdowns appear suddenly after rare volatility shocks.
  
  
• Typical drawdowns fall in the 10–20 percent range but can exceed 30 percent if not hedged.
  
  
• Heavy dependence on volatility filters and execution quality.
  
  

Why drawdowns occur:
Rare market events break mean-reversion assumptions, leading to large one-sided moves.

Who it suits:
Traders who prefer high win-rate systems and understand tail-event behaviour.

Option Selling Strategies: High Stability Until They Fail

Short gamma, short volatility, or premium-selling strategies generate stable returns by collecting option premiums. Their risk is asymmetric: frequent small profits and rare large losses.

Expected risk profile:

• Very smooth equity curve in normal conditions.
  
  
• Low volatility daily returns.
  
  
• High win rate (85–95 percent).
  
  
• Drawdowns occur during IV spikes, events, and gap openings.
  
  
• Well-managed strategies see 10–25 percent drawdowns.
  
  
• Aggressive strategies can see 40–60 percent drawdowns in extreme environments.
  
  

Why drawdowns occur:
Volatility shocks widen spreads and cause short options to move violently, triggering deep losses.

Who it suits:
Traders who prioritise consistency, but can handle the psychological impact of rare large losses.

Intraday Trend or Momentum Systems: Moderate Returns, Medium Drawdowns

These systems follow intraday breakouts or momentum bursts. They rely on execution speed, stable signals, and clean order flow.

Expected risk profile:

• Higher turnover leads to slippage-driven variability.
  
  
• Moderate volatility in returns.
  
  
• Typical drawdowns: 10–25 percent.
  
  
• Return distribution is narrower than multiday trend-following.
  
  
• Slippage can meaningfully increase drawdowns on event-heavy days.
  
  

Why drawdowns occur:
Volatile intraday behaviour, false breakouts, and execution gaps during news announcements.

Who it suits:
Traders who like daily activity and can monitor execution quality.

Scalping and High-Frequency Intraday Systems: Extremely Sensitive to Costs

Scalping strategies rely on capturing minimal edge over large volumes of trades. In India, cost structure and slippage make retail-level scalping difficult.

Expected risk profile:

• Very high turnover; returns are small before costs.
  
  
• Drawdowns increase sharply if costs rise even slightly.
  
  
• Typical drawdowns: 15–30 percent, but can worsen quickly when spreads widen.
  
  
• Performance highly sensitive to broker API stability.
  
  

Why drawdowns occur:
Costs overwhelm the strategy during volatility spikes or low-liquidity moments.

Who it suits:
Traders with excellent execution setups and very low latency.

Buy-and-Hold Equity or Index Portfolios: Low Activity, Large Event-Driven Drawdowns

Buy-and-hold isn’t algo-specific, but remains a benchmark for risk comparison.

Expected risk profile:

• Large drawdowns during market crashes (Nifty drawdown in 2020 was ~40 percent).
  
  
• Long recovery periods.
  
  
• Low turnover means minimal slippage/cost issues.
  
  
• Volatility reflects broad market movement.
  
  

Who it suits:
Long-term investors comfortable riding full market cycles.

Hybrid Trend + Carry + Mean-Reversion Portfolios: More Balanced Drawdowns

Hybrid portfolios diversify across strategy types to smooth out risk.

Expected risk profile:

• Sharper risk-adjusted returns.
  
  
• Individual strategy weaknesses offset each other.
  
  
• Drawdowns generally 15–25 percent depending on mix.
  
  
• Less regime dependency.
  
  

Why drawdowns occur:
System-wide correlation spikes during extreme macro events.

Who it suits:
Traders seeking stable long-term compounding with diversified edges.

How to Interpret Drawdown Profiles Correctly

Regardless of strategy type, every trader must understand two realities:

1. The drawdown you see in backtests will appear again in live trading.
Often deeper.

2. Your capacity to hold through drawdowns determines your actual returns.
Not the strategy’s theoretical returns.

Drawdown depth and duration must guide:

• Position sizing
• Leverage
• Diversification
• Expectations
• Stop-loss frameworks
• Recovery plans

A strategy is only usable if its worst-case behaviour is tolerable.

Using Stratzy Before You Choose a Strategy to Risk-Test

By starting with Stratzy’s setups on https://stratzy.in/, traders avoid the struggle of designing rules from scratch. This speeds up your transition into practical algo trading.