Drawdown

Drawdown is the peak-to-trough decline in the value of a portfolio or position over a specific period. It measures how far you have fallen from your high-water mark, expressed as a percentage.

Formula

drawdown = (current_value - peak_value) / peak_value

A portfolio that hit $100,000 and is now at $82,000 is in a 18% drawdown. Drawdown stays in effect until the portfolio sets a new all-time high, at which point it resets to zero.

Common variants

• Current drawdown — distance from the most recent peak to today
• Maximum drawdown (MDD) — the largest peak-to-trough decline observed over a measurement window
• Drawdown duration — how long it took to recover back to the prior peak

How to read it

• 0% to 5% — normal noise. Not a signal.
• 10% — 20% — a meaningful correction. Common several times per decade in equity portfolios.
• 30% — 50%+ — bear-market territory. Roughly where the S&P 500 bottomed in 2000 – 2002, 2008 – 2009, and briefly in March 2020.

Why it matters more than volatility

Volatility treats up moves and down moves the same. Drawdown focuses only on the part that actually hurts — the loss you are living through. For most investors, the worst drawdown they experience is the constraint that forces a behavioral mistake. A portfolio whose maximum drawdown is too large for the holder to sit through is not a workable portfolio, regardless of what its Sharpe ratio says.

Limitations

• Path-dependent. Two portfolios with identical start and end values can have very different drawdowns.
• Window-sensitive. A 1-year max drawdown and a 10-year max drawdown can be very different numbers.
• Backward-looking. The fact that a strategy has never had a 30% drawdown does not mean it cannot.