What Is Maximum Drawdown? Risk and Loss Measurement Explained
Maximum drawdown is a widely used way to describe the worst peak-to-trough decline an investment experienced over a period. This educational guide explains how to read it.
In this guide
- What maximum drawdown measures
- Why drawdown matters alongside return
- Drawdown vs volatility
- A worked example and limitations
What maximum drawdown means
Maximum drawdown is the largest percentage drop from a previous high point (a peak) to a subsequent low point (a trough) before a new high is reached. It is usually shown as a negative percentage, such as −45%.
Why drawdown matters
Two assets can share a similar long-run growth rate yet feel completely different to hold. Drawdown captures the depth of the declines along the way — information that an average return or CAGR alone hides. It helps illustrate how much an investment could fall, historically, during stressful periods.
Drawdown vs volatility
Volatility measures how much returns fluctuate around their average, in both directions. Drawdown focuses specifically on downside: the size of the worst sustained decline. An asset can be volatile yet recover quickly, or relatively steady yet suffer one deep, prolonged drawdown.
Example
If a hypothetical investment rose to $20,000, fell to $11,000, and later recovered, the maximum drawdown for that episode would be (11,000 − 20,000) / 20,000 = −45%. This is an illustrative figure, not a result for any specific asset.
Limitations
- Drawdown depends on the data window; a longer history may reveal deeper past declines.
- It is backward-looking and does not predict the size of any future decline.
- It says nothing about how long a recovery took, which can matter as much as the depth.
Key takeaway
Maximum drawdown shows the worst peak-to-trough decline in a period. It helps illustrate downside risk that average return or CAGR alone can hide, but it is backward-looking and does not predict future declines.
Common mistakes
- Judging an asset by return alone without checking drawdown
- Assuming a shallow historical drawdown guarantees future safety
- Ignoring how long a recovery took after a deep decline
- Using very short windows that miss past stress episodes