Definition:
Drawdown measures how much an asset has fallen from its highest point to its lowest point before recovering.
What is Drawdown?
Drawdown is the percentage by which an investment falls from its highest value (peak value) to its lowest value (trough value) before it starts recovering.
So, it gives you the maximum range of volatility that an investment asset had in a given period, and on further analysis of charts, you can also find out how much time it took to recover from the trough value.
Example:
A portfolio grows from ₹100 lakh to ₹120 lakh.
It then falls to ₹90 lakh.
Later, it recovers and reaches ₹130 lakh.
Formula for drawdown calculation:
Drawdown = (Peak Value − Trough Value) ÷ Peak Value × 100
If we define the peak and trough, then it would be,
₹120 lakh (peak value)
₹90 lakh (trough value)
Drawdown = (₹120 lakh − ₹90 lakh) ÷ ₹120 lakh × 100 = 25%
Even though the portfolio eventually recovered, an investor had to endure a 25% decline along the way. Drawdown captures how deep the fall was before the recovery began.
Why should the drawdown not be ignored?
Drawdown tells you how much pain you had to endure to make it. The stock can fall a lot before recovering and giving good returns. The period where it falls is very uncertain, and can make investors pessimistic before it recovers, hence making them quit early. On studying the drawdown and recovery period, they will understand the pattern of the stock and make a more informed decision.
Two investments can deliver similar returns, but the one with the smaller drawdown is usually less risky.
Large drawdowns require even larger gains to recover, making recovery more difficult and time-consuming.
Drawdown helps you assess whether you can realistically stay invested during periods of market stress and volatility.
Definition:
Drawdown measures how much an asset has fallen from its highest point to its lowest point before recovering.
What is Drawdown?
Drawdown is the percentage by which an investment falls from its highest value (peak value) to its lowest value (trough value) before it starts recovering.
So, it gives you the maximum range of volatility that an investment asset had in a given period, and on further analysis of charts, you can also find out how much time it took to recover from the trough value.
Example:
A portfolio grows from ₹100 lakh to ₹120 lakh.
It then falls to ₹90 lakh.
Later, it recovers and reaches ₹130 lakh.
Formula for drawdown calculation:
Drawdown = (Peak Value − Trough Value) ÷ Peak Value × 100
If we define the peak and trough, then it would be,
₹120 lakh (peak value)
₹90 lakh (trough value)
Drawdown = (₹120 lakh − ₹90 lakh) ÷ ₹120 lakh × 100 = 25%
Even though the portfolio eventually recovered, an investor had to endure a 25% decline along the way. Drawdown captures how deep the fall was before the recovery began.
Why should the drawdown not be ignored?
Drawdown tells you how much pain you had to endure to make it. The stock can fall a lot before recovering and giving good returns. The period where it falls is very uncertain, and can make investors pessimistic before it recovers, hence making them quit early. On studying the drawdown and recovery period, they will understand the pattern of the stock and make a more informed decision.
Two investments can deliver similar returns, but the one with the smaller drawdown is usually less risky.
Large drawdowns require even larger gains to recover, making recovery more difficult and time-consuming.
Drawdown helps you assess whether you can realistically stay invested during periods of market stress and volatility.