Definition
Drawdown is the peak-to-trough decline in the value of a portfolio, strategy, or account, measured from the most recent high-water mark until a new high is set. It is reported as a percentage — a 30% drawdown means the equity curve has fallen 30% below its prior peak — and it has three companion statistics: maximum drawdown (the worst trough ever observed), drawdown duration (how long the equity stayed below the prior peak), and time to recovery (how long it took to mint a new high).
Where volatility measures the average size of price wiggles, drawdown measures the accumulated worst-case pain. The two are related but not equivalent: a strategy can have low volatility and still suffer a deep drawdown if its losses cluster, and a high-volatility strategy can have shallow drawdowns if its gains and losses interleave. For practitioners who must hold a position through the bad months, drawdown is the number that determines whether the strategy lives or gets liquidated.
Why it matters
How it works
Computing drawdown is mechanical: at each point in the equity curve, track the running maximum so far, then compute the current value divided by that maximum minus one. The result is zero or negative; the running minimum of that series is the maximum drawdown. The same calculation, restricted to a trailing window (rolling max drawdown), tells you how the recent risk profile is evolving even when the all-time peak is far behind. Drawdown duration is the time elapsed between the peak and the eventual new high — often dramatically longer than the drawdown itself, because the recovery climb is from a lower base.
Why drawdown dominates risk discussion in practice has less to do with statistics than with human and institutional behavior. An investor who can intellectually accept a 30% paper loss may liquidate at a 20% loss when actually living through it, locking in the loss and missing the recovery. Funds with redemption notices, margin requirements, or risk-committee oversight face external forced-exit thresholds tied directly to drawdown. The result is that strategies are not just evaluated by their expected return and volatility but by their worst-case path — and the worst-case path is exactly what max drawdown summarizes. Risk-parity construction, position-sizing rules like the Kelly fraction, and stop-loss policies all aim, in part, to control the worst troughs at the cost of some upside.