Calculation and mechanics
For every point of the equity curve the highest value up to that point is recorded. The drawdown is the distance between the current value and that previous high. The largest of these declines in the period under review is the max drawdown. It can be stated as an amount or as a percentage of the previous high. With the formula below it is negative, it is also often written as a positive decline (previous high - current value).
Besides depth, duration matters too. Time in drawdown describes how long, or which share of the period under review, the equity curve stays below an earlier high. Recovery measures the time from the lowest point of the drawdown to a new high. If no new high has been reached yet, the recovery is not yet complete.
Percentage losses are asymmetric. After a decline of 20% a gain of 25% is needed to get back to the starting value. After a loss of 50% it takes a gain of 100%.
Drawdown = current value - previous high
Distinction
The max drawdown describes the largest single decline in the period under review. The Sharpe ratio and the Sortino ratio instead assess return relative to its fluctuations respectively its downside deviations over the whole period. The Calmar ratio relates the annual growth rate directly to the max drawdown.
A drawdown based on realized results is not the same as the drawdown of the whole account. Unrealized losses of open positions only appear in a purely realized equity curve once the position is closed.
Related terms
- Calmar ratio (Drawdown ratio)
- Sharpe ratio (Reward-to-variability ratio)
- Profit factor (PF)
- Realized P&L and total return (Realized profit, total return)
All market and analytical information is provided for educational and analytical purposes only and does not constitute investment advice or a trading recommendation.