Risk & volatility

Drawdown

Drawdown is the percentage decline in an investment or portfolio from its previous peak value to a later value before that peak is regained.

What it means

A drawdown shows how far an investment or portfolio has fallen below an earlier high. It is measured from a peak to a subsequent lower value, not from the original purchase price. A drawdown can be stated as a dollar loss or as a percentage of the peak; the percentage makes different-sized investments easier to compare.

The peak used for an ongoing drawdown is the highest value reached up to the measurement date. If the value later reaches or exceeds that peak, the drawdown ends. Maximum drawdown is a separate measure: the largest peak-to-trough percentage decline observed over a specified period.

How it is calculated

Drawdown (%) = (Peak value − Later value) / Peak value × 100

  • Peak value is the highest earlier value in the period being tracked, measured in US$ in this example.
  • Later value is the value on a subsequent date, measured in the same currency and on the same basis.
  • The result is a percentage of the peak. It is zero when the later value equals the peak and positive when the later value is lower.

For a time series, update the running peak whenever a new high occurs, then calculate drawdown at each later observation. To find maximum drawdown, take the largest of those percentages within the chosen period. Measurement frequency matters: daily observations can miss a larger intraday decline.

Worked example

Suppose a hypothetical portfolio starts at US$10,000, rises to US$12,000, and then falls to US$9,000. Assume these values are measured consistently and exclude deposits and withdrawals.

  1. Identify the earlier peak: US$12,000.
  2. Subtract the later value: US$12,000 − US$9,000 = US$3,000.
  3. Divide by the peak and convert to a percentage: US$3,000 / US$12,000 × 100 = 25%.

The drawdown is 25%, even though the portfolio is only 10% below its initial US$10,000 value. The reference point is the peak, not the starting balance. From US$9,000, a gain of 33.3% would be needed to return to US$12,000: US$3,000 / US$9,000 × 100. That recovery percentage differs because it uses the lower value as its base.

Why it matters before you trade

Drawdown puts a potential decline in terms of the value an investor previously had. Before trading, looking at historical drawdowns can help frame whether a contemplated position or basket fits a personally acceptable loss limit. Historical drawdown does not set a ceiling on future losses: a new decline can exceed any past observation.

It also answers a different question from volatility or value at risk (VaR). Volatility describes the variability of returns; drawdown tracks a sequence of losses relative to a prior high. A 1-day VaR estimate concerns loss over one day at a stated confidence level, not the deepest decline across multiple days. Neither measure guarantees what happens next.

How PreTrAIde uses it

PreTrAIde's stated quantitative measures do not include a drawdown calculation. Its pre-trade analysis instead assesses a proposed stock basket before an order is placed using measures that include daily volatility, 1-day 95% VaR, liquidity and concentration. It returns GO, NO-GO or MODIFY verdicts, risk assessments and reasoning for the basket and each line. These are decision-support outputs, not limits on future drawdown or investment recommendations; users place any trades themselves with their own broker.

A drawdown check can complement that pre-trade risk review by showing how a stock or portfolio value fell from a previous peak. It should not be presented as a PreTrAIde score or as a prediction from its verdict.

Common mistakes

  • Using the purchase price as the peak: Drawdown follows the highest earlier value in the period, which may differ from the entry price.
  • Treating a historical maximum as a worst-case limit: Maximum drawdown describes an observed period, not every possible future decline.
  • Ignoring cash flows: Deposits and withdrawals can distort portfolio-value drawdowns. Use a consistently defined portfolio return series when comparing investment performance.
  • Mixing measurement periods: An intraday drawdown, a daily-closing drawdown and a multiyear maximum drawdown need not be the same.

Frequently asked questions

What is the difference between drawdown and maximum drawdown?

Drawdown measures a decline from a prior peak at a particular later point. Maximum drawdown is the largest such peak-to-trough percentage decline observed during a specified period.

Can a drawdown be larger than 100%?

For an unleveraged investment whose value cannot fall below zero, percentage drawdown cannot exceed 100%. Leverage or liabilities can create losses beyond the original equity, so the measurement basis must be stated.

Why does a 25% drawdown require more than a 25% gain to recover?

The loss is calculated from the higher peak, while the recovery gain is calculated from the lower remaining value. After a fall from US$12,000 to US$9,000, the US$3,000 recovery needed is about 33.3% of US$9,000.

Related terms

Maximum drawdown Maximum drawdown is the largest percentage decline from a prior peak to a subsequent low in an investment’s value over a specified period. Volatility Volatility is a measure of how widely an asset’s returns vary over a specified period, usually expressed as the standard deviation of returns. Value at risk (VaR) Value at risk (VaR) is an estimate of the loss threshold that a position or portfolio is expected to exceed with a specified probability over a specified time horizon. Risk tolerance Risk tolerance is the amount of potential investment loss and uncertainty an investor is willing to accept without abandoning their financial plan. Pre-trade analysis Pre-trade analysis is the assessment of a proposed stock order or basket before placement, estimating execution costs, liquidity and risk to inform the investor’s decision and execution approach.

Risk & volatility

Historical volatility Implied volatility Annualized volatility Daily volatility Parkinson volatility estimator Yang-Zhang volatility estimator GARCH model Expected shortfall (CVaR) All glossary terms →

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Educational content, not investment advice. PreTrAIde is analysis software, not a broker: it never executes orders, and its verdicts are decision support, not recommendations to buy or sell.