Drawdowns

Drawdown is a financial metric that measures the decline from a portfolio’s or index’s prior peak to its subsequent trough. It is typically expressed as a percentage of the peak value but can also be reported in absolute terms. Drawdowns are retrospective by nature and are used to assess downside risk and investor experience over a specified period.

Maximum drawdown (MDD) is the largest observed drop from a peak to a trough before a new peak is achieved. To compute it, track the cumulative peak value, identify the lowest point after each peak, and calculate (peak − trough) / peak for each episode; the largest result is the MDD. For example, a portfolio rising to 100 then falling to 70 has a 30% drawdown.

Other related terms include drawdown duration (time to recover to the peak), rolling drawdown windows, and intraperiod drawdown. In portfolio management, Calmar ratio uses annualized return divided by MDD.

Applications include risk assessment, capital allocation decisions, and evaluating performance consistency. Some investors compare strategies by their maximum drawdown alongside return, volatility, and the Calmar ratio.

Limitations and interpretation: Drawdown depends on the chosen time horizon and data frequency, may obscure the likelihood of future drops, and does not account for recoveries beyond the measured window. It should be interpreted in context with other risk measures.