Drawdown is a measure of risk. As opposed to volatility, which looks at the spread of both positive and negative price returns, drawdown looks specifically at periods when a portfolio has declined in value.
A drawdown measures the decline in a portfolio from a peak to a trough. The drawdown isn’t finalised until the peak has been reached again.
For example, let’s say your portfolio started out at being worth £100 and rose to a peak of £150, before declining to £130. It then rose to £140 before falling again to £120. It then climbed to £160. In this case, the drawdown is from the peak of £150 to the trough of £120. In this case, the drawdown is £30, or 20%.
In a particular period, there could be many drawdowns, so an often recorded statistic is the maximum drawdown. This is the biggest drop in portfolio value during the period.
Maximum Drawdown is a useful metric to look at, as it tells us the maximum loss that actually occurred for a portfolio during a period in time. From a risk perspective, while more difficult to extrapolate and use in further calculations, it has the benefit of purely looking at downturns, and being a real event that occurred with tangible financial impact.
Another useful thing to look at is the time it took the portfolio to recover from a drawdown as this points to the portfolio’s resilience.