BAJAJ FINSERV DIRECT LIMITED

Our Products

Loans

Cards

Insurance

Investment

Stock Market

Electronics Mall

CIBIL Score

Knowledge Centre

Calculators

Stocks Insights

What Is a Drawdown? Meaning, Examples & How to Calculate

Anshika

Discover what a drawdown is to learn how declines from a portfolio’s peak help measure investment risk and recovery time.

Drawdown is one of the most important risk indicators used in trading and investing. It tells you how much an investment has fallen from its peak before recovering. Whether you trade equities, mutual funds, crypto, or manage a portfolio using technical or quantitative models, understanding drawdowns helps you evaluate risk, measure strategy performance, and determine whether a downturn is within acceptable limits.

Drawdown: Definition & Meaning

A drawdown refers to the decline in the value of an investment or portfolio from its highest point (peak) to its lowest point (trough) over a specific period. It is expressed as a percentage and highlights the amount of capital lost during a downturn.

Drawdowns help answer questions such as:

  • How much loss can your portfolio experience in a worst-case scenario

  • How volatile is your trading strategy

  • Is the current decline an ordinary fluctuation or a major risk signal

A smaller drawdown reflects a lower magnitude of decline, while deeper drawdowns show a larger reduction from the peak.

Types of Drawdown

Drawdowns can be classified into different types based on duration and measurement approach:

1. Absolute Drawdown

The difference between your initial investment and the lowest equity value seen after that point. This is important for evaluating risk relative to starting capital.

2. Maximum Drawdown (MDD)

The biggest peak-to-trough drop observed during a specific period. MDD is widely used in backtesting, portfolio analysis, and quant models.

3. Relative Drawdown

The percentage decline from the highest portfolio value. It helps compare risk across different strategies or asset classes.

4. Drawdown Duration

The length of time an investment takes to recover from a downturn. A strategy with long drawdown periods may look profitable but can be psychologically stressful and operationally risky.

Drawdown Formula & How to Calculate

The standard formula for calculating drawdown is:

  • Drawdown = (Peak Value – Trough Value) / Peak Value × 100

Where:

  • Peak Value = highest value reached

  • Trough Value = lowest value after the peak

Steps to Calculate Drawdown

  1. Identify the highest value your investment or portfolio achieved.

  2. Identify the lowest value reached after the peak.

  3. Apply the drawdown formula.

Maximum Drawdown Formula

Maximum Drawdown = Largest observed drawdown over the analysis period.

Examples of Drawdown

Consider the following examples:

Example 1: Simple Investment Drawdown

  • Peak portfolio value: ₹10,00,000

  • Trough value after decline: ₹7,00,000

Drawdown = (10,00,000 – 7,00,000) / 10,00,000 × 100 = 30%

This means the portfolio fell 30% from its peak.

Example 2: Trading Account Drawdown

Drawdown = (5,00,000 – 4,25,000) / 5,00,000 × 100
Drawdown = 15%

A 15% drawdown indicates moderate risk exposure.

Example 3: Maximum Drawdown Across Time Period

If the portfolio experiences:

  • First fall: 10%

  • Later fall: 25%

  • Final fall: 18%

The maximum drawdown would be 25%, the largest peak-to-trough drop.

Why Drawdowns Matter: Significance & Risks

Understanding drawdowns is important for traders and investors because:

1. Shows declines differently than volatility

Volatility shows price fluctuations but not actual losses. Drawdowns reflect actual capital reduction.

2. Helps Set Stop-loss and Position Sizing

Traders use drawdown data to define acceptable risk levels and size positions accordingly.

3. Evaluates Performance of Trading Strategies

A strategy with high returns but deep drawdowns is riskier than one with moderate returns and small drawdowns.

4. Psychological Preparedness

Deep drawdowns are emotionally taxing and may lead traders to exit positions prematurely.

5. Portfolio Recovery Impact

Higher drawdowns require disproportionate returns to recover.
Example: A 50% drawdown requires a 100% gain to break even.

Conclusion & Key Takeaways

Drawdown analysis helps reveal how much risk a portfolio carries during market fluctuations. It highlights the depth and duration of losses, offering a clearer understanding of downside exposure than return-based metrics alone. Regularly reviewing drawdowns supports decision-making, improves resilience, and keeps risk aligned with investment goals.

Key Points to Note:

  • Drawdown tracks the fall from a portfolio’s peak to its lowest point.

  • Maximum drawdown is essential for assessing long-term risk and strategy durability.

  • Understanding drawdowns illustrate potential portfolio value changes.

  • Smaller drawdowns reflect efficient risk control and stability.

  • Monitoring drawdowns is vital for traders and portfolio managers alike.

Disclaimer

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

FAQs

What exactly is drawdown?

Drawdown refers to the decline in a portfolio’s value from its highest point to the subsequent lowest point before any recovery begins. It reflects the depth of a temporary setback.

How is drawdown calculated in trading?

Drawdown is calculated by comparing the portfolio’s peak value with the lowest value recorded after that peak, using the drawdown formula to express the decline as a percentage or absolute amount.

What is maximum drawdown?

Maximum drawdown represents the largest peak-to-trough decline observed over a specified period. It highlights the worst historical drop an investment has experienced.

Why is drawdown duration important?

Drawdown duration measures how long it takes for an investment to rebound from its trough to the previous peak. It is a key indicator of strategy resilience and influences investor confidence.

Is drawdown the same as loss?

Drawdown is not the same as a realised loss. It describes a temporary fall in value, whereas a loss is confirmed only when the investor exits or closes the position during the downturn.

Hi! I’m Anshika
Financial Content Specialist

Anshika brings 7+ years of experience in stock market operations, project management, and investment banking processes. She has led cross-functional initiatives and managed the delivery of digital investment portals. Backed by industry certifications, she holds a strong foundation in financial operations. With deep expertise in capital markets, she connects strategy with execution, ensuring compliance to deliver impact. 

Home
Steal Deals
CIBIL Score
Free Cibil
Accounts
Explore