Max Drawdown
The largest peak-to-trough decline in portfolio value over a specific period, expressed as a percentage. It measures the worst-case loss an investor would have experienced.
Max drawdown captures the single worst decline from a high point to a subsequent low point before a new high is established. Unlike standard deviation, which treats upside and downside volatility equally, max drawdown focuses exclusively on downside risk—the scenario investors fear most.
Why It Matters
A portfolio that drops 50% needs a 100% gain just to break even. Max drawdown helps you understand the real emotional and financial stress an investment strategy can produce. During the 2008 financial crisis, the S&P 500 experienced a max drawdown of roughly 55%, while a diversified 60/40 portfolio drew down about 35%.
When backtesting a portfolio, always examine the max drawdown alongside total return. A strategy that returned 12% annually with a 60% max drawdown may be unsuitable for an investor who would panic-sell during the downturn. Understanding your risk tolerance is essential to choosing a strategy whose drawdowns you can withstand.