What Is Recovery Factor?
Recovery factor is net profit divided by maximum drawdown, so it measures how much return a strategy produced per unit of its worst decline. A strategy earning $18,000 with a $6,000 worst drawdown has a recovery factor of 3.0.
What is the formula?
Recovery factor = net profit ÷ maximum drawdown, both in the same units.
Worked example. A strategy nets $18,000 over a year with a worst peak-to-trough decline of $6,000. Recovery factor = 18,000 ÷ 6,000 = 3.0. A second strategy nets $30,000 with a $20,000 drawdown: 30,000 ÷ 20,000 = 1.5. The second earned more and was substantially harder to hold.
What does it capture that profit factor does not?
Path. Profit factor compares gross wins to gross losses and is entirely indifferent to their order — a strategy that made its money smoothly and one that made it after a terrifying hole can have identical profit factors.
Recovery factor puts the hole in the denominator, which is closer to the experience of trading the strategy. Two systems with a profit factor of 1.6 and recovery factors of 4.0 and 0.9 are different products.
What is a reasonable value?
Above 1.0 means the year's profit exceeded the worst drawdown, which is a low bar and one a surprising number of strategies fail. Values in the 2 to 5 range over a full year are healthy. Anything much higher usually means the sample has not yet contained a bad period.
Where does it mislead?
Time is not in it. Net profit over one year and net profit over four are not the same claim, and the formula does not know which it was given. Annualise the numerator or state the period.
Maximum drawdown is a single observation. A short record has had fewer chances to produce a deep one, so a young strategy gets a flattering denominator for free.
It rewards not having been tested. The best way to improve recovery factor quickly is to have avoided a bad market rather than to have survived one.
The fix is the same as everywhere else: state the period, the number of trades, and the dates the worst drawdown spanned. Three numbers turn a ratio into a claim someone can check.
How does this connect to a track record?
Reporting return against the worst drawdown rather than in isolation is the same instinct behind the GIPS standards, which require fair representation and full disclosure across every portfolio in a composite rather than a flattering selection.[1] A return with no drawdown beside it is an incomplete presentation, whatever the number is.
It is worth reporting because the accounts that never recovered are not here to report anything. That is survivorship bias — the failures never enter the count — and counting only the ones that made it was shown on funds in 1992 to produce the look of skill from nothing.[2]
A metric is a summary of a record, so it inherits every weakness of that record. Computed from trades selected after the fact, it is a number about the selection. kappi commits each trade before it resolves and publishes it on a Merkle-anchored log, so PnL, RME, correlation to SPX, mean R:R and trade count over 30, 100 and 200-day windows are computed over everything that was committed, losses included. $15/month to keep a record; reading one is free.
Sources
Frequently asked questions
How do you calculate recovery factor?
Net profit divided by maximum drawdown. $18,000 of net profit against a $6,000 worst decline is a recovery factor of 3.0.
What is a good recovery factor?
Above 1.0 means the profit exceeded the worst drawdown. Values of 2 to 5 over a full year are healthy; much higher usually means the record has not yet included a difficult period.
How is recovery factor different from profit factor?
Profit factor compares gross wins to gross losses and ignores their order. Recovery factor divides net profit by the worst peak-to-trough decline, so it reflects the path the account actually took.
What makes recovery factor misleading?
It contains no time dimension, and maximum drawdown is a single tail observation. A young record has had fewer chances to produce a deep drawdown, which flatters the ratio for free.