CluenexWhat is a drawdown?
A drawdown is how far your portfolio has fallen from its most recent peak, shown as a percentage. It starts when value drops below the high and ends when a new high is reached.
It matches how investing feels. You remember the high, you see the lower number today, and the gap between them is the drawdown.
Maximum drawdown (MDD) is the largest of all such drops during a chosen period. It answers a blunt question: what was the worst fall someone holding this would have lived through?
How do you calculate maximum drawdown?
Track the running peak, measure how far each value sits below it, and take the most negative result. The formula for any single date is:
Drawdown = (Current Value − Running Peak) ÷ Running Peak
Steps:
- Record your portfolio value at regular intervals, such as month-end.
- For each date, note the highest value seen so far (the running peak).
- Compute the drawdown for each date with the formula.
- Maximum drawdown is the most negative number.
Worked example:
| Month | Value | Running peak | Drawdown |
|---|---|---|---|
| Jan | $100,000 | $100,000 | 0.0% |
| Feb | $108,000 | $108,000 | 0.0% |
| Mar | $115,000 | $115,000 | 0.0% |
| Apr | $98,000 | $115,000 | −14.8% |
| May | $88,000 | $115,000 | −23.5% |
| Jun | $95,000 | $115,000 | −17.4% |
| Jul | $112,000 | $115,000 | −2.6% |
| Aug | $120,000 | $120,000 | 0.0% |
The May math: ($88,000 − $115,000) ÷ $115,000 = −23.5%. That is the maximum drawdown. The portfolio was underwater from April through July and set a new high in August.
Monthly data can hide the true low inside a month, so daily values give a slightly deeper and more honest number.
Why does a 50% loss need a 100% gain?
Because gains and losses apply to different starting amounts. After a loss you have less money, so the same percentage gain adds fewer dollars.
The gain needed to get back to even is 1 ÷ (1 − loss) − 1.
| Drawdown | Gain needed to recover |
|---|---|
| −10% | +11.1% |
| −20% | +25.0% |
| −30% | +42.9% |
| −40% | +66.7% |
| −50% | +100.0% |
| −75% | +300.0% |
Example: $100,000 falls 50% to $50,000. A 50% gain only brings it to $75,000. It must double to $100,000.
Time matters too. At a steady 10% a year, recovering from a 20% loss takes about ln(1.25) ÷ ln(1.10), or roughly 2.3 years. Recovering from a 50% loss takes ln(2) ÷ ln(1.10), or about 7.3 years. Real returns are never steady, so treat these as rough guides.
How big have US stock market drawdowns been?
The S&P 500 has had several drops of 25% or more, and the deepest in modern times was about 57% in the 2007 to 2009 financial crisis. Exact figures vary slightly by whether you use price only or total return and daily or monthly closes.
| Episode | Approximate peak to trough decline (price) |
|---|---|
| Dot-com bust, 2000 to 2002 | about 49% |
| Financial crisis, 2007 to 2009 | about 57% |
| COVID crash, Feb to Mar 2020 | about 34% |
| Rate-hike bear market, 2022 | about 25% |
The COVID drop was fast and recovered within months, while the financial crisis took years. Depth and duration are different kinds of pain, so check both.
What is the Calmar ratio and how do you use it?
The Calmar ratio is annualized return divided by maximum drawdown, using the same period for both. It shows how much return an investment delivered for the worst fall it put you through.
Example: a portfolio that grew 12% a year with a 30% maximum drawdown has a Calmar ratio of 12 ÷ 30 = 0.4. One that grew 9% a year with a 15% maximum drawdown scores 0.6, so it was the smoother ride per unit of return.
The ratio has no official pass mark. Use it only to compare two things over the same dates. Related measures include maximum drawdown duration (how long you stayed below the old peak) and the Ulcer Index, which blends depth and duration.
How can you reduce drawdowns?
The reliable levers are how much you hold in stocks, how spread out you are, and how much cash you keep. Each trades some upside for a shallower fall.
- Asset mix: A portfolio with 60% stocks and 40% bonds usually falls less than one with 100% stocks. See How to Diversify a Stock Portfolio.
- Position size: Capping any one holding limits how much a single failure can hurt. See What is Position Sizing and Concentrated Stock Positions.
- Beta: A portfolio with a beta (sensitivity to the market) below 1 tends to fall less than the market in a broad decline. See What is Portfolio Beta.
- Cash and rebalancing: Holding cash for near-term needs means you do not have to sell stocks at a low. See Portfolio Rebalancing.
- Hedges: Options or inverse funds can offset losses but cost money and add complexity. See How to Hedge a Stock Portfolio.
No method guarantees a smaller drawdown in the next downturn. Correlations tend to rise in a crisis, so diversification helps less than it looks in calm years.
Where does drawdown analysis fall short?
Maximum drawdown looks backward and depends entirely on the window you pick. It says nothing about whether a future fall will be bigger.
Common mistakes:
- Treating history as a ceiling. The worst drop on record is not the worst possible drop. A new one can exceed it.
- Assuming everything recovers. An index of hundreds of companies has recovered every time so far, but individual stocks can fall 90% and never return. Enron and Lehman Brothers are well known examples.
- Comparing different windows. A fund with a 3-year history looks safer than one with a 20-year history simply because it missed a crisis.
- Ignoring behavior. A 50% drawdown on paper is easy to accept. Living through it is not, and selling near the low locks in the loss.
- Mixing up volatility and drawdown. Volatility measures the typical size of swings in both directions. Drawdown measures the actual fall from a high.
Drawdown for a single stock works the same way: (Current Price − Highest Price) ÷ Highest Price. A deep drawdown can mean a bargain or a broken business, so the cause matters more than the number. See Value Trap vs Bargain.
What this means for you
Pick a drawdown you could sit through, then work backward to your stock share. Ask yourself what you would do if your balance fell 35% and stayed there for two years. If the honest answer is sell, hold less in stocks now.
Practical habits:
- Calculate your own maximum drawdown from your account history, not just the index.
- Keep money you need within five years out of stocks.
- Use the recovery table to understand why avoiding a deep fall is worth some lost upside.
- Rebalance on a schedule so a long rally does not quietly raise your risk.
- Write down your plan for a 30% drop before it happens.
Cluenex stock pages show business quality scores, including a financial health check, and the main risk for each stock, which helps you judge whether a deep drop in a holding reflects a weak business. Find any stock at https://cluenex.com/stocks/ with its lowercase ticker.