Maximum Drawdown

Maximum drawdown shows the worst loss an investor would have suffered if they had bought at the highest point and sold at the lowest point during a period.

For example, a portfolio that rises to 120,000, falls to 84,000 and then recovers has a drawdown of 36,000 from the peak, or 30%. If that is the largest fall in the period, it is the maximum drawdown.

Investors find this measure intuitive because it reflects the real experience of losing money. Volatility measures how much returns fluctuate, but maximum drawdown captures the depth of the worst decline.

Drawdowns also highlight the mathematics of recovery. A 30% fall requires a gain of about 43% to return to the previous peak, and a 50% fall requires a 100% gain.

Maximum drawdown is useful for assessing whether an investment suits an investor's risk tolerance. Someone who would panic and sell after a 20% fall may struggle with an investment that has historically had drawdowns of 40% or more. Like all historical measures, past drawdowns do not guarantee the size of future ones.