Drawdown — Trading Wiki

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Published by TradeHQ. Site creator: Anuga Weerasinghe. This page has no recorded editorial review date; the About page explains the site's editorial approach.

What Drawdown means

Drawdown measures a decline from a previously observed peak to a later lower value, including an unfinished decline. Maximum drawdown is the largest such decline in a specified sample, not a ceiling on future loss.

In depth

Drawdown measures a decline from an observed peak to a later lower value within a defined series. Maximum drawdown is the largest such peak-to-trough decline in the chosen sample, not the worst loss that could occur in the future. State whether observations include fees, cash flows and mark-to-market positions; an end-of-day sample can miss an intraday trough. A drop from $100 to $80 is 20%, but recovering from $80 to $100 requires 25%. Deposits can make raw portfolio-value comparisons misleading. The arithmetic does not diagnose stress or predict whether someone would tolerate a real loss.

Key points

• Observed peak-to-trough decline under the specified valuation and sampling method
• 50% drawdown requires 100% gain to recover — math is asymmetric
• Calmar ratio compares a defined annualised return with maximum drawdown; the sample and assumptions matter

Why it matters when you are learning

Calculate the decline from the relevant peak and state the observation period. Historical maximum drawdown is not an upper bound on future loss, and no universal percentage is a suitable limit for everyone.

Worked exercise and its limits

An invented portfolio peaks at $100,000 and falls to $80,000: drawdown is 20%. Returning to the peak needs $20,000/$80,000 = 25% growth. Deposits can distort a raw-value comparison; this example assumes none.