What it means
Most performance figures describe where an investment ended up, not what it felt like along the way. Maximum drawdown fills that gap by measuring the single deepest slide in value over a chosen period, from the highest point to the lowest point that came after it.
A fund that gained 10% a year but once fell 40% along the way has a very different risk story from a fund that never fell more than 8%. In a business setting the idea applies well beyond share portfolios.
A treasury team can track the maximum drawdown in its cash reserves, a sales leader can track the biggest fall in monthly recurring revenue, and an investment committee can compare it across fund managers. Because it looks only at the worst stretch, it is easy to explain to a board and hard to dress up.
To calculate it, you walk through the history of values and keep a running record of the highest value seen so far. At each point you measure how far the current value sits below that running peak, and the largest gap you ever see is the maximum drawdown.
It is normally quoted as a negative percentage, though some people drop the minus sign. The measure has important limits.
It depends heavily on the period you choose, so a fund measured over three calm years can look safer than the same fund measured over ten. It also says nothing about how long the slump lasted or how quickly the value recovered, so it is often paired with a recovery-time measure.
Maths matters here too, because losses and gains are not symmetrical. After a 35% fall you need a gain of roughly 54% just to get back to the old peak, which is why professional investors treat deep drawdowns with such respect.
Maximum drawdown is also the denominator in the Calmar ratio, which divides annual return by the worst drawdown.
In practice
Real-world examples.
Example
A pension fund committee compares two equity managers who both returned about 9% a year over a decade. Manager A had a maximum drawdown of -22% while Manager B had -41%. The committee appoints Manager A because members could tolerate the smoother ride.
Example
A software company keeps $5,000,000 of surplus cash in a short-dated bond fund. The CFO sets a policy that the fund must never have shown a maximum drawdown worse than -3% over the last five years. This keeps the cash close to a deposit-like experience even though it is not a deposit.
Example
A retail investor reviews a cryptocurrency holding and sees that its price once dropped from $60,000 to $18,000 before partly recovering. The maximum drawdown is (18,000 - 60,000) / 60,000 = -70%. She decides to cut her position size because she knows she could not sit through another fall of that depth.
Formula
Calculation
Maximum drawdown = (Trough value - Peak value) / Peak value
Suppose a portfolio rises from $100,000 to a peak of $120,000, then slides to a low of $78,000 before recovering. The fall is 78,000 - 120,000 = -$42,000. Dividing by the peak gives -42,000 / 120,000 = -0.35, so the maximum drawdown is -35%. To get back to the peak the portfolio must then grow by 120,000 / 78,000 - 1, which is about 53.8%.Case study
Seen in the real world.
Harbourlight Capital is an illustrative, fictional investment boutique with two flagship funds. Both reported identical annual returns of 8% over six years, and the sales team pitched them as equivalent.
When the risk officer calculated maximum drawdown, the Growth Tilt fund showed -34% while the Steady Income fund showed -9%. The Growth Tilt fund had fallen sharply during one bad year and had needed almost three years to climb back to its old high, a story that the headline return had completely hidden.
Harbourlight changed its factsheets to show maximum drawdown next to return for every fund. In this illustrative case the number of clients who withdrew during the next downturn fell noticeably, because investors had been warned in advance what a bad stretch could look like.
Watch out
Common mistakes.
- Measuring drawdown from the starting value instead of from the highest value reached, which understates the fall whenever the investment rose before it dropped.
- Comparing maximum drawdowns taken over different time periods, which makes a fund measured through a crisis look unfairly dangerous next to one measured only in calm markets.
- Assuming the worst past drawdown is the worst that can happen, when a future fall can easily be deeper than anything in the historical record.
Questions
People also ask.
Is maximum drawdown the same as volatility?
No, volatility measures how widely returns swing around their average, whereas maximum drawdown measures only the single largest peak-to-trough loss.
Why is a -50% drawdown so hard to recover from?
Because the investment must then double, a gain of 100%, to return to its previous peak.
Can maximum drawdown be used for a business metric such as revenue?
Yes, you can apply the same peak-to-trough calculation to monthly revenue, cash balances or customer numbers to show the deepest slump in a period.
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