Drawdown Rules in Prop Firm Trading: Balance vs Equity

Last Updated on January 12, 2026

For prop firm traders, it is important that they understand drawdown rules. These rules determine whether you pass or fail your evaluation. These rules are the primary reason traders lose their accounts.

Traders often pass the challenge stage with strong profits and lose their funded account due to a single rule breach. Violating the drawdown rule in a prop firm is caused by a confusion between balance drawdown and equity drawdown.

What is Drawdown?

Drawdown refers to the process of reducing your trading account from its peak value to its lowest point prior to reaching a new peak. In simpler terms, it measures how much your trading amount has declined from its highest point.

In prop firm trading, drawdown rules serve as a risk management mechanism. They ensure the protection of the firm’s capital.

Most prop firms implement two types of drawdown limits: maximum drawdown and daily drawdown.

Maximum drawdown is calculated from your initial starting balance and never changes. If you start with a $100,000 account and have a 10% maximum drawdown rule, your account can never drop below $90,000.

Daily drawdown resets at the end of each trading day. It is calculated from either your starting balance of the day or your equity at the day’s start. Well, it completely depends on prop firm rules.

Understanding the drawdown is absolutely essential before you place your first trade.

Balance Drawdown vs Equity Drawdown

This is where confusion often sets in. The two methods calculate drawdown differently. Underestimating the distinction can lead to account violations.

Balance Drawdown

It refers to the reduction in your account balance purely based on closed trades. It does not consider your floating or unrealized profit/loss. This means your actual is counted when a trade is closed. As long as your losing trades remain open and unclosed, they do not affect the balance drawdown calculation.

This type of drawdown gives traders more breathing room. This type of drawdown is beneficial for those who rely on swig trading that need time to develop before showing profit.

Example of Balanced-based Drawdown

Imagine you start with $100,000 with max balance drawdown 10%. So, you are allowed to lose $10,000. After taking a few trades and closing some losing positions, your balance drops to $94,000.

Later, you open a new position that goes into an unrealized loss of -$5,000, causing your equity to fall to $80,000. Even though your equity is below the drawdown limit, you have not violated the rule.

Since your balance remains at $94,000, which is still above the $90,000 minimum.

Equity Drawdown

 It is one of the strictest risk parameters used by prop firms. It measures the real-time decrease in your account by including both closed trades and unrealized (floating profit or loss.

Unlike balance drawdown, equity drawdown constantly fluctuates as the market moves. This makes it more sensitive, more demanding, and significantly more challenging for traders.

Your equity is equal to balance plus open profit and loss. This value updates every second as price changes. Under an equity-based rule, prop firms monitor this number continuously. Even a temporary or momentary equity dip below the allowed threshold counts as a violation.

Equity drawdown functions through three core principles: your equity changes in real time, floating losses count toward your drawdown, and the drawdown limit is based on starting equity or the highest equity achieved.

Under this structure, traders must think differently about risk. You can not allow a trade to breathe too much because any excessive floating loss may cause your equity to break the limit even if your overall balance is still safe.

Example of Equity-Based Drawdown

Imagine you start with $100,000 in balance and equity, and your maximum allowed equity drawdown is $10,000. It means your equity must never fall below $90,000. After a closing a series of losing trades, your balance drops to $94,000.

After that you open a new position that goes into a floating loss of -$5,000. This brings you to your real-time equity down to $89,000. This dip immediately triggers a drawdown violation.

Why Drawdown Type Matters for Traders

Understanding the difference between balance-based drawdown and equity-based drawdown is a fundamental factor that shapes how you manage risk, structure your trades and maintain psychological pressure.

The difference between them is even more important when trading with prop firms, where breaking a rule can instantly invalidate your entire evaluation or funded account.

Risk Per Trade

With balance drawdown, floating losses do not count against your limit. This means that your open positions can temporarily dip into negative without immediately breaching your account.

Traders often feel more comfortable using slightly wider stop-losses or holding trades through short-term pullbacks.

With equity-based drawdown, every pip that moves against you instantly reduces your equity and pushes you closer to violating your drawdown limit. There is no buffer zone.

Even a small position can breach equity rules of the market becomes volatile. So, adopt a far more conservative approach to position sizing.

Trading Style Implications

Drawdown structure also determines which trading style are realistically viable under each rule.

Balance-based drawdown is ideal for traders who rely on strategies that requires patience. It is suitable for swing traders, position traders, and trader using wider stops.

Such traders and their trading styles naturally involve moments when the trade goes into floating drawdown before heading toward the profit target.

Equity-based drawdown is suitable for day traders, scalpers and traders with tight stop losses and high frequency. Traders must stay flat or lightly exposed because equity drawdown tracks every movement in real time.

Psychological Pressure

Equity drawdown brings intense psychological pressure because you must constantly monitor you live equity. Many traders prematurely close wining trades simply because the floating loss shook their confidence. The environment test emotional discipline at a much deeper level.

Balance drawdown alleviates this pressure because you don’t need to obsess over every tick of floating loss. You can focus on you trading plan and allow trades to run smoothly.

Common Mistakes that Violate Drawdown Rules

Here are the most common mistakes that traders make:

• Many traders assume that all prop firms use the same drawdown rules. This is false. Some firms use balance drawdown for maximum drawdown but equity drawdown for daily limits.
• With equity drawdown, traders often forget that their open positions count toward their limit.
• Daily drawdown resets at a specific time (usually 5 PM EST). Some traders open positions before the reset and watch them move against them after the reset, not realizing that their new daily limit has been established.
• After a losing streak, emotional traders often increase position sizes to “make back” losses quickly.
• Many prop firms require a certain number of trading days to pass evaluation. Traders sometimes overtrade on these days, taking unnecessary risks that breach drawdown limits just to meet the day count requirement.

Tips to Stay Within Drawdown Limits

Now that you understand drawdown rules and common mistakes, here are the actionable strategies to help you maintain discipline.

• Before you ever place a trade, determine the maximum you can risk without breaching limits.
• Place your stop loss immediately when you open a position.
• If you’ve had a few losing trades and are at 60-70% of your maximum drawdown limit, consider: reducing position sizes by 50%, taking fewer trades, pausing trading for the day to reassess, and focusing on high-probability setups only.
• Know exactly when your daily drawdown resets. Set calendar reminders.
• Don’t use your full allowed drawdown. If you have a 10% maximum drawdown limit, aim to never exceed 6-7%.
• Drawdown rules are violated more often due to emotional trading than technical mistakes. When you feel frustrated, anxious, or overly confident step away from the platform.

Final Thought

These drawdown rules directly influence how much risk you can take, which strategies you can use, and how you manage open positions. Choose a prop firm that matches your trading style. This increases the chance of passing funded account evaluation process.

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