What Is Drawdown? How to Measure Losses and Recovery
Ben Ghabili · Published
A portfolio can finish a period with a good return after suffering a substantial decline along the way. The final return does not reveal the loss from its earlier peak or how long recovery took.
Drawdown describes that path. Understanding its measurement helps distinguish an observed historical loss from a future risk limit.
What is drawdown?
Drawdown is the decline in an investment or portfolio series from its previous peak. At each observation, compare the current value with the highest value reached up to that point. State whether you report the decline as a negative return or a positive loss magnitude.
This article reports percentage drawdown as a positive loss magnitude:
Drawdown = (previous peak − current value) ÷ previous peak × 100.
At a new peak, drawdown is zero. Maximum drawdown is the largest observed peak-to-later-trough percentage decline in the specified period and sampled series. The relevant peak must precede the trough; subtracting the lowest value from a later highest value is not a drawdown calculation.
How is drawdown different from a loss since purchase?
A loss since purchase uses the purchase price or starting value as its reference. Drawdown uses the previous peak. The two can differ materially, including when the investment remains profitable relative to its starting point.
Consider a fictional account, observed at five consecutive session closes. All values are invented, in USD. There are no deposits, withdrawals or distributions, and values are assumed net of any costs already incurred.
| Relative session | Account value | Highest value so far | Drawdown magnitude |
|---|---|---|---|
| 1 | $10,000 | $10,000 | 0% |
| 2 | $12,000 | $12,000 | 0% |
| 3 | $9,000 | $12,000 | 25% |
| 4 | $10,800 | $12,000 | 10% |
| 5 | $12,600 | $12,600 | 0% |
At observation 3, the account is 10% below its initial $10,000. Its drawdown is nevertheless 25%, because it declined $3,000 from the $12,000 peak.
At observation 4, the account is above its initial value but still 10% below its prior peak. It has not yet recovered that peak.
Across the complete observed sequence, the starting-to-ending gain is 26% and the maximum drawdown is 25%. Both statements are correct and describe different aspects of the path. Intermediate intraday values were not supplied, so the example does not establish an intraday maximum drawdown.
The old $12,000 peak is first regained in the supplied closing observations at session 5, two session steps after the session 3 trough. No calendar dates or intraday path are supplied, so an exact calendar recovery duration cannot be inferred.
Why does recovery require a larger percentage gain?
A decline reduces the base from which the recovery percentage is calculated. Therefore, a gain of the same percentage as the preceding loss does not restore the original peak.
For a fractional loss d, greater than or equal to zero and less than one, the gain needed to regain the peak is:
Required recovery gain = d ÷ (1 − d) × 100.
| Drawdown magnitude | Gain needed to regain the peak |
|---|---|
| 10% | Approximately 11.11% |
| 20% | 25% |
| 25% | Approximately 33.33% |
| 50% | 100% |
In the fictional account, $9,000 must gain $3,000, or approximately 33.33%, to return to $12,000. A 25% gain from $9,000 would reach only $11,250.
These are mathematical recovery requirements without new cash contributions. They are not predictions that an investment will recover. At a 100% loss, the remaining value is zero, so a finite percentage gain cannot restore the original capital on that same base.
What can make two drawdown reports incomparable?
Reports can use different sampling frequencies, value definitions, costs and treatment of cash flows. Those choices affect the observed drawdown, so compare definitions before comparing percentages.
Important distinctions include:
- Daily closes versus intraday values. A closing series can miss losses that occurred between observations.
- Realised results versus total account equity. A closed-trades record can omit losses on still-open positions.
- Price versus total-return series. Dividends and distributions affect the economic result and need consistent treatment.
- Gross versus net performance. Fees and trading costs affect what the investor retains.
- Dollar versus percentage drawdown. The largest dollar decline and largest percentage decline need not occur at the same time.
State the start date too. Beginning the sample after an earlier peak can exclude part of a decline. Maximum drawdown is always conditional on the record you measured.
How should deposits and withdrawals be handled?
External cash flows should not be mistaken for investment gains and losses. A withdrawal can reduce account value without the portfolio losing money; a deposit can mask an investment decline.
If analysing investment performance, use an appropriately cash-flow-adjusted return series or unitised portfolio value, and document the method. If analysing the amount of money available in the account, raw account value may be relevant, but it answers a different question.
Do not silently combine these purposes. A report that calls a withdrawal a drawdown in investment performance misstates what happened.
Can historical maximum drawdown limit future losses?
No. Historical maximum drawdown is the worst decline observed in a selected past sample, not a guaranteed maximum for the future. Different conditions, leverage, execution or exposures can produce a larger loss.
A short or favourable sample may omit the conditions that would cause the most damage. Even an extensive history cannot contain every possible future outcome.
Likewise, a planned stop is not the same as a guaranteed portfolio loss limit. Gaps, poor liquidity and execution differences can affect the actual outcome. Risk controls should be assessed on their own assumptions rather than inferred from a backtest's maximum drawdown.
How is drawdown different from volatility?
Volatility describes variability in returns under a chosen measurement method. Drawdown describes a decline from a prior peak. They are related aspects of a return path, but one is not a substitute for the other.
An investor may experience the same final return through different sequences of gains and losses. Those sequences can produce different drawdowns and different practical demands, even before considering leverage or withdrawals.
A drawdown review checklist
- 1.Identify the series: instrument price, total return, total equity or realised trades.
- 2.Record dates, observation frequency, currency and cost treatment.
- 3.Explain how external cash flows are handled.
- 4.Track the running peak before calculating each decline.
- 5.Record the maximum magnitude and its peak/trough observations.
- 6.Record whether and when the series regained that peak.
- 7.Separate observed history from any proposed future risk limit.
For your next performance review, calculate drawdown alongside the overall return. Write down both the worst observed decline and the limitations of the series. A final gain tells you where the record ended; drawdown helps describe what happened before it got there.
Nothing here is investment advice.