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Key Takeaways
- Drawdown is measured from the running peak, so the reference point changes only after a new high is established.
- Maximum drawdown is the largest peak-to-trough decline within the selected history.
- A percentage loss requires a larger percentage gain to recover because the recovery starts from a smaller base.
- Drawdown depth, duration, and time to recovery describe different aspects of the same loss episode.
- Historical drawdown depends on the sample, valuation frequency, and treatment of deposits, withdrawals, and leverage.
What is drawdown?
Drawdown is the decline in an account, portfolio or price series from its running peak, measured in dollars or as a percentage. It is zero at a new high and negative below it, and the episode lasts until the prior peak is recovered. Maximum drawdown is the deepest peak-to-trough decline in the selected history.
How is drawdown calculated?
Drawdown compares the current value with the running maximum, including the current observation. A value at a new high has zero drawdown. Below that high, the percentage drawdown is negative.
Maximum drawdown is the deepest decline in the selected series. A 12% decline followed by recovery and then a 19% decline produces a 19% maximum drawdown depth for that history.
Formula
Running peak at t = max(value from start through t); drawdown at t = (current value ÷ running peak − 1) × 100%; recovery gain = (peak ÷ trough − 1) × 100%- Include the current observation in the running maximum. Drawdown is zero at a new high and negative below that high. Percentage drawdown uses a positive peak; the recovery formula uses a positive trough.
- Maximum drawdown is the most negative drawdown in the selected series.
Drawdown example: why recovery takes a larger gain
With no external deposits or withdrawals, an account rises to an $80,000 peak, falls to $60,000 and returns to $80,000.
- ($60,000 − $80,000) / $80,000 = −25% drawdown
- $80,000 / $60,000 − 1 = 33.33% gain required for recovery
- $80,000 − $60,000 = $20,000 dollar drawdown
The episode has a 25% peak-to-trough drawdown, but the account needs a 33.33% gain from the trough to recover its prior peak.
Returning from $60,000 to $80,000 requires $20,000 ÷ $60,000 = 33.33%. The recovery starts from the lower base. A 20% decline similarly requires a 25% gain; a 50% decline requires a 100% gain.
Drawdown depth vs duration
The chart’s peak occurs at observation seven, its trough at observation thirteen and its recovery at observation twenty-one. That is six intervals down and eight intervals back, or 14 intervals from peak to recovery.
Compare dollar depth, percentage depth and elapsed time separately. The displayed series has 13 observations strictly below the peak between the peak and recovery points.
Account drawdown: cash flows, costs and valuation
For investment performance, separate external deposits and withdrawals from returns. Include open positions, costs and financing in the selected account-value record. Use the same valuation frequency and return basis when comparing strategies.
For cash planning, also inspect actual balances, buying power and obligations. A performance return index and an account cash balance answer different questions.
Drawdown and position sizing
Review the contribution from each setup and position. Compare return, drawdown depth, recovery time and portfolio exposure when setting trade budgets. Size option positions from their worst case: the Options Profit Calculator shows each structure’s maximum loss across price, date and volatility. Value open positions the same way as closed ones so each payoff connects with the account path.
Limitations of drawdown
- Size for a deeper decline than the record holds. Maximum drawdown is one historical event: extending the same history can only keep or deepen it, and the worst decline so far does not cap the next one.
- Compare drawdowns at the same valuation frequency. Month-end values can miss an intramonth trough that daily values show.
- Adjust the series for deposits and withdrawals, and state how it treats leverage. External cash flows distort account drawdown unless the series is adjusted for them, and the treatment of leverage also changes the figure.
- Measure duration beside depth. Two drawdowns of equal depth can differ widely in how long they take to reach the trough and to recover.
Bottom line
Drawdown shows how far an account or strategy has fallen from its high and how long it stays below it. Use maximum drawdown, duration and the recovery gain together to set position sizes and loss budgets, measured on a series adjusted for deposits and withdrawals and valued at a consistent frequency.
Clear answers
Frequently Asked Questions
Sources and Further Reading
- Charles Schwab: The Ups and Downs of Stock Market Volatility
- CFA Institute Research: Maximum Drawdown as a Predictor of Mutual Fund Performance and Flows
How entries are sourced, calculated and updated: editorial methodology.