Equity Based Drawdown is a drawdown rule that measures losses using account equity rather than balance. Since equity includes unrealized profit and loss from open trades, this drawdown type reacts in real time to market movements. A violation occurs the moment equity falls below the allowed drawdown threshold, even if trades are still open.
Prop firms use equity based drawdown to control risk more aggressively. This model prevents traders from holding large floating losses and encourages tighter trade management.
Why Equity Based Drawdown Matters in Prop Trading
Equity based drawdown requires constant awareness of open positions. Traders cannot rely on closing trades later to avoid violations, since floating losses already count toward the limit. This makes risk management and position sizing especially important.
Traders who understand equity based drawdown can adjust stop losses and exposure more carefully. While this model is stricter, it reduces the chance of large losses developing during volatile market conditions. Choosing a firm with this drawdown structure should align with the trader’s strategy and holding period.
Example of Equity Based Drawdown
A trader starts with a 100000 account and an equity based drawdown limit of 90000. While holding an open position, the unrealized loss reaches 11000 and equity drops to 89000. Even though the trade is not closed, the account is immediately breached because equity has fallen below the allowed limit.