The term High Watermark is used when calculating incentive fees for account managers. It makes sure that the manager does not earn an incentive (or performance) fee until the combined profits on an account reach a new all-time high.

The term is derived from the tides. If you think of your account balance as the level of the sea, you’ll know that it rises and falls. When it’s “high tide” the water reaches a high point on the shore. An even higher tide marks a higher point on the shore. It is the very highest mark on the shore which must be surpassed if the account manager is to earn an incentive fee. (Incentive fees are the same as performance fees).

When trading activities result in a net loss, this will of course reduce your account balance. The high watermark rule requires that no incentive fee is paid unless your account balance returns to it’s previous high for the month.

Note the chart below, which assumes a 20% incentive fee. Even though the manager made a profit in the second month, no fee is taken, since the profit was not enough to bring the balance back to the high watermark of $162,325.