Definition
Drawdown is the decline from a peak in value to a later low, usually shown as a percentage. Maximum drawdown is the largest such decline over a given period for an account, portfolio, strategy or asset.
How it works
Drawdown = (low − previous peak) ÷ previous peak × 100. It is measured from the highest value reached so far, not from the starting value, so an account can be in profit overall and still be in a drawdown. Maximum drawdown records the deepest fall from any peak to the following low within the period studied.
Losses and recoveries are not symmetrical. The gain needed to return to the peak = 1 ÷ (1 − loss) − 1. A 10% drawdown needs about an 11% gain, a 25% drawdown needs about 33%, and a 50% drawdown needs a 100% gain. This is one reason traders limit the size of each position to keep drawdowns shallow.
Drawdown duration, the time from a peak until the value gets back to it, matters as much as depth, because long periods below a previous high are hard to sit through. Maximum drawdown is based on past data, so a future drawdown can be deeper. Results also depend on whether daily closing values or intraday lows are used, which differs between tools and data providers.
Example (hypothetical numbers)
Suppose a $10,000 account grows to a peak of $15,000, then falls to $9,000, and later recovers to $12,000.
Drawdown at the low = ($9,000 − $15,000) ÷ $15,000 = −40%.
Recovery needed = 1 ÷ (1 − 0.40) − 1 = about 66.7%, the gain from $9,000 back to $15,000.
At $12,000 the account is still ($12,000 − $15,000) ÷ $15,000 = −20% below its peak, even though it is 20% above its $10,000 start.
A 40% fall needs a much larger percentage gain to recover, and drawdown is measured from the peak, not from the start.
Common mistakes
- Measuring drawdown from the starting balance instead of from the previous peak.
- Assuming a 40% loss is undone by a 40% gain.
- Treating a strategy's past maximum drawdown as the worst that can happen.
Related calculators
This glossary is for education only and is not investment advice. Examples use hypothetical numbers.