Glossary term
Drawdown
Definition
The fall from a previous peak to a later trough, as a percent of that peak. A quiet market can still strand you in a deep hole.
How it works
Drawdown is the fall from a previous peak to a later trough, expressed as a percent of that peak: (peak − trough) / peak. It is computed from the order of values, not just their spread, so the same set of returns can produce very different drawdowns depending on how losses cluster. The maximum drawdown is the worst such fall within a sample.
Depth is half the story. Duration, how long the book stays below its old high, is the other half. Recovery is also asymmetric: to climb back from a fall of d you need a gain of d / (1 − d), because the gain is applied to a smaller base than the loss was.
Worked example
A hypothetical book peaks at $100,000 and falls to $80,000. Drawdown is ($100,000 − $80,000) / $100,000 = 20%. Getting back to $100,000 needs $20,000 on a base of $80,000, which is a 25% gain.
The asymmetry grows quickly. A 50% fall needs 0.50 / 0.50 = a 100% gain, and an 80% fall needs 0.80 / 0.20 = 400%. The course also contrasts two hypothetical books: one with 8% volatility and a 31% worst drawdown needs 31 / 69 = 44.9% to recover, while a book with 24% volatility and a 12% worst drawdown needs 12 / 88 = 13.6%.
Hypothetical, for education only. Not a recommendation and not a prediction.
Common mistake
The mistake is judging a track record by volatility or by return alone and ignoring the hole. A quiet market can still strand a book deep below its high for years, and a quoted maximum drawdown with no recovery time is only half a statement. The fall that matters most in practice is the one deep and long enough that a plan gets abandoned partway through it.