The reduction of an asset’s peak value to its lowest point over a specific period.
A Drawdown is the measurement of how much an asset, portfolio, or strategy declines from its peak value to its subsequent lowest point. It reflects the severity of losses over a specific period and is a key indicator of risk.
Drawdowns help traders understand the downside potential of an investment.
How Drawdowns Are Calculated
Drawdown = Peak Value → Lowest Value (before recovery)
Example: If a portfolio rises to $10,000 and then falls to $7,500, the drawdown is:
$2,500 in value
25% drawdown
Drawdowns continue until the asset returns to the previous peak (a “new high”).
Why Drawdowns Matter
Risk assessment: Shows how much value can be lost during market stress.
Strategy evaluation: High drawdowns may signal unstable or aggressive strategies.
Capital protection: Helps determine position sizing and stop-loss levels.
Psychological resilience: Large drawdowns test investor discipline.
Drawdown severity often determines whether an investor can stick with a strategy long-term.
Types of Drawdowns
Maximum Drawdown: Worst peak-to-trough decline over a period.
Relative Drawdown: Drawdown relative to account balance.
Absolute Drawdown: Loss compared to initial deposit or capital.
Each metric highlights different aspects of performance risk.
Drawdowns in Crypto
Because crypto markets are highly volatile:
Drawdowns can exceed 60–80% in bear markets
Rapid corrections are common
Leverage increases drawdown risk significantly
Understanding drawdowns is essential for proper risk management.
Summary
A drawdown measures how far an asset or portfolio falls from its peak before recovering. It’s a critical metric for evaluating risk, volatility, and the resilience of a trading strategy.
