The underwater plot visualizes how far below peak equity you are at every moment. Unlike the equity curve which shows absolute portfolio value, the underwater plot shows only the painful part: your drawdowns.
How to Read the Chart
The Axes
- X-Axis (Horizontal): Time progression through your backtest
- Y-Axis (Vertical): Drawdown percentage (always zero or negative)
- Zero Line: No drawdown, you're at a new equity peak
- Below Zero: In a drawdown, the deeper the line goes, the worse the loss
Basic Patterns
| Pattern | What You See | What It Means |
|---|---|---|
| Touching zero | Line reaches the top | New equity high, recovered from previous loss |
| Valley | Line drops then rises | Drawdown period followed by recovery |
| Flat valley floor | Line stays at same depth | Stuck in drawdown, not recovering |
| Sharp drop | Sudden vertical plunge | Large rapid loss, possibly single bad trade |
| Gradual slope down | Steady decline | Accumulating small losses over time |
The Good Patterns
Pattern 1: Quick V-Shapes
Shape: \ /\ /\ / Means: Fast recoveries, resilient strategy Example: Drop to -8%, recover to 0% in 5 days
Why it's good: Strategy doesn't stay in drawdown long. Capital recovers quickly, you can trade through rough patches without long psychological stress.
Pattern 2: Shallow and Rare
Shape: ___/\___/\________ Means: Small drawdowns, mostly at peaks Example: Typical DD is -3%, max is -8%
Why it's good: Low variance, predictable returns. Easy to trade psychologically because losses are small and brief.
Pattern 3: Regular Rhythm
Shape: /\ /\ /\ /\ Means: Consistent drawdown/recovery cycle Example: 10-day drawdowns, 5-day recoveries, repeats
Why it's good: Predictable behavior. You know roughly when to expect drawdowns and how long they'll last.
The Bad Patterns
Pattern 1: Long Flat Valleys
Shape: \________/ Means: Extended underwater periods Example: 60-day drawdown before recovery
Why it's bad: Capital is tied up for months. Psychologically draining. You're paying opportunity cost waiting for recovery.
Pattern 2: Stair-Step Down
Shape: \_\_\_
\_\_\_
\_\_
Means: Gradually deepening losses
Example: -5%, then -8%, then -12% over time
Why it's bad: Each recovery attempt fails, going deeper. Suggests strategy is broken or market conditions changed. Classic sign to exit.
Pattern 3: The Abyss
Shape: \
| <- Vertical drop
|
____
Means: Sudden catastrophic loss
Example: -25% in 2 days, then flat
Why it's bad: Severe tail risk. One event can destroy months of gains. Strategy lacks proper risk controls.
Pattern 4: Never Surfacing
Shape: \_______________ Means: No new peaks, perpetual drawdown Example: Entered drawdown 6 months ago, still there
Why it's bad: Strategy is dead. You're not making new highs, just slowly losing money or staying flat. Exit immediately.
Valley Shape Analysis
V-Shaped Valleys (Good)
Quick down, quick up. Indicates:
- Mean-reverting strategy that recovers fast
- Short holding periods
- Good risk management with quick stop losses
U-Shaped Valleys (Moderate)
Gradual down, flat bottom, gradual up. Indicates:
- Strategy takes time to work
- Longer holding periods
- Need patience, capital tied up during bottom
W-Shaped Valleys (Concerning)
Multiple attempts to recover that fail. Indicates:
- False breakouts, strategy keeps failing
- Market conditions not favorable
- Each recovery attempt gets sold off
L-Shaped Valleys (Disaster)
Drop and never recover. Indicates:
- Strategy broke completely
- Catastrophic loss followed by inability to recover
- Time to stop trading this strategy
Reading Valley Width
Narrow Valleys (10-20 bars)
- Short drawdown periods
- Quick turnaround
- Active strategy with frequent trades
- Capital isn't locked up long
Wide Valleys (50-100 bars)
- Extended drawdown periods
- Passive strategy or long holding times
- Need significant patience
- Opportunity cost is high
Multiple Valleys vs. Single Deep Valley
Scenario A: Many Shallow Valleys
Max DD: -10% Number of valleys: 15 Typical valley: -5%, 10 days Interpretation: High frequency trading, lots of small drawdowns, recovers quickly. Easier to trade psychologically.
Scenario B: Few Deep Valleys
Max DD: -10% Number of valleys: 3 Typical valley: -8%, 40 days Interpretation: Rare but severe drawdowns. Long recovery times. Harder to trade, capital locked up longer.
Both have the same max drawdown, but Scenario A is preferable for most traders.
Warning Signs to Act On
1. Valley Getting Deeper Over Time
If you're in a drawdown and it keeps getting worse:
- Day 1-10: -5%
- Day 11-20: -8%
- Day 21-30: -12%
Action: This is the stair-step pattern. Exit now, don't wait for -15%.
2. Valley Wider Than Usual
If current drawdown has lasted 2x longer than typical:
- Typical valley width: 15 days
- Current valley: 35 days and counting
Action: Reduce position size by 50%, prepare to exit if it hits 60 days.
3. Valleys Not Reaching Zero
If you haven't made a new high in 3+ months:
- Last peak: January 15
- Current date: May 1
- Highest recent point: Still 5% below January peak
Action: Strategy is degrading. Review and likely stop trading.
4. Increasing Valley Frequency
If valleys are happening more often recently:
- First 6 months: 4 valleys
- Last 3 months: 6 valleys
Action: Strategy may be losing its edge or market conditions changed.
Comparing Strategies
Use underwater plots to compare two strategies side by side:
Strategy A (Better)
- Multiple shallow valleys (-3% to -7%)
- Quick recoveries (5-15 days)
- Reaches zero frequently
- No extended flat periods
Strategy B (Worse)
- Few but deep valleys (-5% to -20%)
- Slow recoveries (30-60 days)
- Long periods between new highs
- Extended flat underwater periods
Even if both have similar total returns, Strategy A is superior due to better drawdown characteristics.
Setting Exit Rules Based on Underwater Plot
Rule 1: Maximum Valley Width
If current valley exceeds 60 consecutive bars below zero, exit the strategy entirely.
Rule 2: Maximum Valley Depth
If drawdown exceeds 20% and shows no recovery after 30 bars, reduce position size to 25% or stop trading.
Rule 3: New Low in Existing Valley
If you're 30+ days into a drawdown and it drops to a new low (deeper than any point in the past 30 days), exit immediately.
Rule 4: Time Since Last Peak
If you haven't touched zero (new equity high) in 90+ days, pause trading and reevaluate strategy.
Real-World Example
Reviewing a strategy's underwater plot reveals:
- 12 valleys total over 18 months
- Typical valley: 10 days, -6% depth
- One outlier valley: 87 days, -18% depth
- Valley widths are increasing: early valleys 8 days, recent valleys 15 days
Analysis:
- The 87-day valley is a major red flag, far outside the norm
- Increasing valley width suggests deteriorating edge
- This strategy would have forced a 3-month underwater period
- Not suitable for traders who need regular access to capital
Decision: High risk strategy. Either don't trade it, or only allocate capital you won't need for 4+ months.
Common Misinterpretations
- Thinking zero is a target: Zero just means new high, not profit. A strategy constantly at zero isn't necessarily great, might just be flat.
- Ignoring valley width: A -5% drawdown for 90 days is worse than -10% for 10 days in terms of opportunity cost.
- Only looking at max depth: Average depth and frequency matter more for real trading experience.
- Not tracking recovery speed: Two valleys of same depth but different recovery times are very different experiences.
What Great Underwater Plots Look Like
Professional-grade strategies typically show:
- Valleys reaching zero at least 3-4 times per year
- No single valley wider than 45 days
- Max drawdown less than 20%
- Median drawdown less than 5%
- Consistent valley widths (not increasing over time)
- V-shaped or U-shaped valleys, not L-shaped
In VivaTrades
The underwater plot appears in the Risk Analysis tab. Hover over any point to see the exact drawdown percentage, peak equity, and current equity. Use this visualization alongside confidence bands and duration metrics to get a complete picture of your strategy's risk characteristics.