Maximum drawdown measures the largest peak-to-trough decline a portfolio experienced over a given period, expressed as a percentage. A fund that fell 30% from its high before recovering has a maximum drawdown of 30%, regardless of how it performed afterward.
Why It Matters
Drawdown is what investors actually feel, unlike volatility or Sharpe Ratio which are statistical abstractions. Allocators use it to size positions and set redemption expectations, since a strategy with a 40% historical drawdown needs a much larger subsequent gain (67%) just to break even — the asymmetry that makes large losses so hard to recover from.
How It Works in Practice
- 1Track the portfolio's cumulative value over time and identify each new peak
- 2Measure the decline from each peak to the subsequent trough before a new peak is reached
- 3The maximum drawdown is the largest of these peak-to-trough declines over the period measured
- 4Drawdown duration (time to recover to the prior peak) is often reported alongside it
Common Pitfalls
Maximum drawdown is backward-looking and period-dependent — a fund's worst drawdown may simply not have happened yet within the measured window
It says nothing about how the loss occurred (one sharp event vs. a slow grind), which matters for understanding whether the risk is repeatable
Comparing drawdowns across strategies with different volatility profiles without context can be misleading — a 15% drawdown on a low-volatility strategy is a very different signal than 15% on a high-volatility one