What is drawdown?
- Author
- CRYPTO PORT Editorial
- Published
- Updated
- Reading time
- 4 min
In short
Drawdown measures how far an asset or portfolio has fallen from its most recent peak, and maximum drawdown is the worst such fall over a period. Its value lies in describing the declines endured, rather than the gains achieved.
Key points
- The percentage fall from the most recent peak
- Maximum drawdown is the worst such fall in a period
- Recovery needs a larger rise than the fall
- Change the window and the number changes
Definition
The percentage decline from a running peak to a subsequent trough. The largest such decline in a period is the maximum drawdown, commonly used as a measure of risk.
You track it by resetting the reference each time a new peak is set, then measuring the fall from there. A peak of 100 followed by a trough of 60 is a 40 per cent drawdown, and the drawdown persists until the old peak is exceeded.
The asymmetry is what people underestimate. An asset down 50 per cent needs a 100 per cent rise to get back; down 70 per cent, it needs roughly 233 per cent. The size of a drawdown weighs on you as the size of the recovery it demands.
The measure is used to think in advance about how much decline you could actually sit through. Past drawdowns are verifiable facts, but nothing guarantees future ones stay within the same range. Since the number depends on the window and the asset measured, always check what conditions produced it.
Watch out for
- · A past maximum drawdown is not a ceiling on future declines
- · Leverage magnifies account drawdown for the same price move
- · A short measurement window makes the risk look smaller than it is