What it means
Maximum drawdown describes the worst peak-to-trough fall observed in a value series over a chosen period. The series could track one stock or an entire portfolio. Each low must occur after the peak used to measure it; subtracting the lowest value from an earlier low or a later high would not measure a drawdown.
It is usually reported as a positive percentage loss. A 25% maximum drawdown means the value fell 25% from a preceding high at some point in the period. It does not mean the investment ended the period down 25%, nor does it describe how long a recovery took. The observation window matters: extending it can reveal a deeper decline.
How it is calculated
At each observation, compare the current value with the highest value recorded up to that point. Then select the largest resulting decline:
Peak_t = max(V_0, V_1, ..., V_t)
Drawdown_t = (Peak_t - V_t) / Peak_t
Maximum drawdown = max(Drawdown_t) for all observations t in the period
V_tis the stock or portfolio value at observationt, measured in currency units such as US$.V_0is the starting value. Include it when establishing the first peak.Peak_tis the highest value observed from the start throught, in the same currency units.Drawdown_tis the decline from that peak, expressed as a fraction; multiply by 100 for a percentage.
For a portfolio, specify whether the series includes dividends, fees, deposits and withdrawals. Cash flows can change account value without reflecting investment gains or losses, so a cash-flow-adjusted series is preferable when comparing investment performance. The formula also requires positive peak values; it is not directly meaningful for a series whose peak is zero or negative.
Worked example
Suppose a hypothetical portfolio has the following values at five month-ends, with no deposits or withdrawals:
| Month-end | Value | Highest value so far | Drawdown |
|---|---|---|---|
| 1 | US$10,000 | US$10,000 | 0% |
| 2 | US$12,000 | US$12,000 | 0% |
| 3 | US$9,000 | US$12,000 | 25% |
| 4 | US$11,000 | US$12,000 | 8.33% |
| 5 | US$8,000 | US$12,000 | 33.33% |
- By month 2, the highest observed value is US$12,000.
- At month 3, the decline is
(US$12,000 - US$9,000) / US$12,000 = 25%. - At month 5, the decline is
(US$12,000 - US$8,000) / US$12,000 = 33.33%. - The maximum drawdown is 33.33% across these observations. The partial rebound in month 4 did not establish a new peak.
Because these are month-end figures, an intramonth low could have produced a larger maximum drawdown on daily data.
Why it matters before you trade
Maximum drawdown makes a past loss concrete in a way that an average return or volatility figure may not. A decline of 33.33% requires a subsequent gain of approximately 50% from the lower value to regain the prior peak. That arithmetic can help put a proposed position size or concentration level in context.
Before a trade, distinguish a historical maximum drawdown from a potential future loss. The historical figure depends on the chosen dates, observation frequency, valuation method and whether total returns are included. It cannot set a reliable limit on what might happen next. A single-stock history may also differ substantially from the drawdown of the broader portfolio that holds it.
How PreTrAIde uses it
The product facts do not say that PreTrAIde calculates or reports maximum drawdown. Its pre-trade analysis instead assesses a proposed stock basket using measures including estimated daily volatility, one-day 95% value at risk, liquidity, market impact and portfolio concentration. These measures address different questions; none is interchangeable with the largest observed peak-to-trough decline over a historical period.
PreTrAIde returns GO, NO-GO or MODIFY verdicts as decision support, not recommendations. Its success probability is a model estimate, not a guarantee or a forecast of returns. A user considering historical drawdown would need to evaluate it separately from those pre-trade checks.
Common mistakes
- Using the final return instead: A portfolio can finish above its starting value and still have experienced a substantial drawdown along the way.
- Pairing dates incorrectly: The trough must follow the peak, and every observation uses the highest value reached by then.
- Mixing sampling frequencies: Month-end data can miss losses visible in daily or intraday data.
- Ignoring cash flows: Deposits and withdrawals can distort drawdown calculated from an unadjusted account balance.
- Treating history as a loss ceiling: A past maximum is an observation, not a limit on future declines.