What does maximum drawdown mean?
Maximum drawdown is the largest percentage decline from a portfolio's prior peak to a later low during the period being measured. It helps describe the path an investor would have experienced, not only where the portfolio began and ended.
The decline is measured from the earlier high, even if the portfolio remains above its original starting value. A 30% loss also requires a gain of about 42.9% from the low to return to the prior peak because the recovery begins from a smaller base.
Identify the prior high
The calculation begins with the highest portfolio value reached before a subsequent decline.
Find the lowest later value
The trough is the lowest point before a new peak is established or before the measurement period ends.
Measure the percentage decline
Depth indicates how much value was lost from the peak. It does not show how quickly the loss occurred.
Consider time below the peak
Two strategies can have similar drawdown depth but very different decline and recovery periods.
- The deepest historical loss from a prior high.
- How a strategy's downside compared with its benchmark.
- Whether higher returns came with a more difficult path.
- A historical period worth examining in greater detail.
- The worst decline that could happen in the future.
- How an investor would react or whether they would remain invested.
- The complete risk of a short, reconstructed, or backtested record.
- Whether a strategy fits an investor's goals and financial capacity.
FINRA defines risk as the possibility of a negative financial outcome that matters to the investor and notes that risk tolerance includes both willingness and ability to accept loss. Review its investment risk guide alongside return, annual results, concentration, benchmark comparisons, and recovery time.
Use the research evidence to compare model and SPY drawdowns over the same backtest window, then keep that research separate from the shorter forward-tracked profile records.