Drawdown

How it is measured

Drawdown is measured continuously against the running high water mark, not against a fixed starting point. A portfolio that rises then falls back to its start has a drawdown even though it has not lost money relative to where it began.

The figure is path dependent, which is what makes it different from volatility. Two portfolios can have identical volatility and very different maximum drawdowns depending on whether the bad days clustered together.

How to read it

Recovery is not symmetric with the fall, and this is the single most important arithmetic in the concept. A fall of twenty percent requires a twenty five percent gain to get back. A fall of fifty percent requires a hundred percent gain. The deeper the hole, the more disproportionate the climb out.

Drawdown is also the number most closely tied to behaviour. Returns are what you were paid; drawdown is what you had to sit through to collect it, and it is the reason most people abandon strategies that would have worked.

A worked example

A portfolio compounding at eight percent a year with a worst fall of twenty three percent and one compounding at the same rate with a worst fall of fifty five percent are not the same product. The second one is far more likely to be sold at the bottom, which converts a paper drawdown into a permanent loss.

The most common mistake

Comparing returns without comparing drawdowns. A strategy can be made to look better on return alone simply by taking more risk. The pair has to be read together, and if the drawdown would have made you sell, the return column is hypothetical for you.

How CORVIX uses it

CORVIX reports maximum drawdown alongside the trough date and recovery in every backtest, and the client report puts the return and the drawdown in the same sentence deliberately. It also runs a timing-luck stress test, because when you deposited changes the drawdown you personally experienced.

Common questions

What is Drawdown?

A drawdown is the fall from a portfolio's previous peak to its subsequent low, expressed as a percentage. Maximum drawdown is the largest such fall over a period, and it measures the worst experience an investor holding throughout would have lived through.

How is drawdown measured?

Drawdown is measured continuously against the running high water mark, not against a fixed starting point. A portfolio that rises then falls back to its start has a drawdown even though it has not lost money relative to where it began. The figure is path dependent, which is what makes it different from volatility. Two portfolios can have identical volatility and very different maximum drawdowns depending on whether the bad days clustered together.

What is the most common mistake when using drawdown?

Comparing returns without comparing drawdowns. A strategy can be made to look better on return alone simply by taking more risk. The pair has to be read together, and if the drawdown would have made you sell, the return column is hypothetical for you.