What is Recovery Factor in Trading?
Quick Answer: Recovery factor divides net profit by maximum drawdown, revealing how efficiently a system rebounds after losses and how productively it uses risk capital.
Understanding Recovery Factor
Recovery factor measures how efficiently a strategy rebounds from drawdowns. It is calculated by dividing net profit by maximum drawdown. A recovery factor above 3 indicates robust performance; anything below 1 suggests the system struggles to bounce back.
Why Recovery Factor Matters
Two strategies can post identical returns, but the one with a higher recovery factor endured smaller drawdowns. Monitoring this ratio helps you judge whether new profits compensate for past pain. Investors and prop firms rely on it to compare managers.
Tracking Example
If your system is up $12,000 with a peak-to-trough drawdown of $3,000, recovery factor equals 4. Maintain this ratio as you scale to ensure capital efficiency.
Improving Recovery
Enhance recovery factor by cutting losing strategies quicker, diversifying your portfolio, and reducing leverage during turbulent regimes. Combine it with metrics like max drawdown and profit factor for a complete picture.
Ignoring Capital Efficiency
Strategies with weak recovery factors may still be profitable but tie up capital for long periods. That opportunity cost can drag overall performance.
Related Terms
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