Published on: 2026-01-14
Equity drawdown refers to the decline in the value of an investment from its historical peak to its lowest point before recovery. Investors use drawdown to measure the risk associated with a particular investment strategy or portfolio.
For example, if a portfolio reaches a peak of $100,000 and then drops to $80,000, the drawdown is $20,000 or 20%.
Drawdown is not permanent. It only measures the reduction from the peak value and does not indicate a total loss. By tracking drawdowns, investors can understand their tolerance for risk and the volatility of their assets.
Real-Life Examples of Equity Drawdown
Understanding equity drawdown becomes clearer with examples from real portfolios. Consider an investor who purchased 1,000 shares of a tech company at $100 per share.
Peak Value: $120,000 (share price rises to $120)
Trough Value: $90,000 (market correction drops share price to $90)
Drawdown: $30,000 or 25%
Even though the drawdown may appear severe, it does not represent a permanent loss unless the shares are sold at the trough. Long-term investors often experience similar declines during market cycles, emphasising the importance of patience and risk management.
In another example, a diversified portfolio of stocks, bonds, and ETFs may experience smaller drawdowns. Suppose a $500,000 portfolio drops to $450,000 due to a market slump:
Drawdown: $50,000 or 10%
Insight: Diversification reduced volatility and mitigated the impact of individual asset declines.
These scenarios show that drawdown magnitude depends on portfolio composition, market conditions, and investor behaviour.
Equity drawdown is not only a numerical concept but also a psychological challenge. Investors often react emotionally during downturns, which can lead to poor decision-making. Common behavioural responses include:
Panic selling (selling investments at a loss out of fear), overconfidence post-recovery (Investing recklessly after a rebound), and analysis paralysis (avoiding investment decisions due to fear of future drawdowns.
Professional investors and fund managers use drawdown metrics to maintain discipline, ensuring that emotions do not interfere with strategic decision-making. Developing a plan for expected drawdowns before investing can prevent impulsive actions.
Drawdowns vary depending on the type of investment. Understanding how different assets behave is crucial:
Stocks: Tend to have higher drawdowns due to market volatility but offer higher potential returns.
Bonds: Generally experience smaller drawdowns but are sensitive to interest rate changes.
Mutual Funds and ETFs: Reflect the performance of the underlying assets; diversification can limit drawdowns.
Cryptocurrencies: Can experience extreme drawdowns of over 50% during market corrections, highlighting the importance of risk tolerance.
Knowing the expected drawdown range for each asset type helps investors plan their allocations and avoid unwelcome surprises.
Consider a hypothetical investor, Jane, with a $200,000 portfolio split 60% in equities and 40% in bonds. During a market correction:
Equity portion drops 25%, resulting in a $30,000 decline. Bond portion declines 5%, resulting in a $4,000 loss. Total portfolio drawdown: $34,000 or 17%.
Jane had a pre-defined risk limit of 20% drawdown. Since her drawdown did not exceed the limit, she maintained her strategy, rebalanced her portfolio, and avoided panic selling. Over the next 12 months, markets recovered, and her portfolio regained its peak value.
This example demonstrates the value of planning, risk limits, and understanding drawdowns in maintaining long-term investment success.
Investors can leverage technology to track drawdowns:
Portfolio management software (many platforms automatically calculate drawdowns and visualise them over time), spreadsheets (a simple method for manual tracking using peak and trough values), and trading platforms (they offer drawdown analytics for individual strategies or accounts).
Regular monitoring helps investors react proactively, not reactively, to market changes.
Understanding the different types of drawdowns can provide deeper insight into investment risk.
Absolute Drawdown
Measures the decline in an investment from the initial investment amount. It helps investors understand the initial risk exposure.
Maximum Drawdown
The largest observed drop in a portfolio from peak to trough. Often used by fund managers to evaluate risk-adjusted performance.
Relative Drawdown
Expressed as a percentage of the peak value. Useful for comparing portfolios of different sizes or strategies.
Calculating equity drawdown involves a simple formula:
Drawdown ($) = Peak Value – Trough Value
Drawdown (%) = (Peak Value – Trough Value) ÷ Peak Value × 100
For example:
Peak value: $150,000
Trough value: $120,000
Drawdown ($) = $150,000 – $120,000 = $30,000
Drawdown (%) = ($30,000 ÷ $150,000) × 100 = 20%
This calculation can be applied to individual stocks, mutual funds, or an entire investment portfolio.
Several elements affect drawdown size and duration:
Market volatility (high volatility increases the likelihood of significant drawdowns), investment horizon (short-term investments may experience larger drawdowns than long-term holdings), diversification (well-diversified portfolios typically experience smaller drawdowns), and leverage (using borrowed funds can magnify both gains and losses, increasing drawdown potential).
Monitoring drawdowns allows investors to set risk limits for their portfolios, evaluate performance against benchmarks, maintain emotional discipline, prevent panic selling during declines, and adjust portfolio allocations proactively.
Drawdown is a measure of risk, not performance. A high return does not always mean low risk, and even profitable portfolios can experience substantial drawdowns.
It is important to differentiate between drawdown and loss: Drawdown measures the decline from a peak and is temporary, while loss is the realised reduction in capital after selling an investment.
For instance, if your portfolio drops from $100,000 to $80,000, the drawdown is $20,000. If you sell at $80,000, the loss becomes realised.
Ignoring drawdown history: Past declines provide insights into potential future risks.
Over-leverage: Borrowing excessively amplifies drawdowns and increases the chance of forced liquidation.
Chasing returns: Investing in high-performing assets without considering drawdown risk can lead to emotional decision-making.
Neglecting diversification: Concentrated portfolios are more prone to severe drawdowns.
Being aware of these pitfalls helps investors adopt a disciplined, data-driven approach.
Review the historical drawdowns of an asset or fund to anticipate potential volatility. Ensure drawdown levels align with personal risk tolerance to avoid panic selling. Use risk management tools such as stop-losses, hedging, and rebalancing to limit drawdowns. Short-term drawdowns are less critical if the long-term growth trajectory remains intact.
Table 1: Sample Drawdown Calculation
1. What is a safe level of equity drawdown?
There is no universal safe level. Conservative investors may aim for 5-10%, while more aggressive portfolios can tolerate 20-30%. It depends on risk tolerance, investment horizon, and portfolio size.
2. How can I recover from a large drawdown?
Recovery requires a disciplined approach, including portfolio rebalancing, reducing exposure to high-risk assets, and maintaining a long-term investment perspective to ride out market volatility.
3. Does drawdown affect all types of investments equally?
No. Equities generally have higher drawdowns than bonds or cash. Diversification across asset classes can reduce overall portfolio drawdown.
4. Can drawdowns be predicted?
Predicting exact drawdowns is difficult. Historical analysis helps anticipate potential declines, but market conditions, economic events, and geopolitical factors always introduce uncertainty.
5. Is a small drawdown always better?
Not necessarily. Small drawdowns may indicate conservative growth, but they may also result in lower returns. Investors must balance risk and potential reward based on their objectives.
Equity drawdown is a fundamental measure of investment risk that every investor should understand. By tracking declines from peak values, investors can make informed decisions, implement risk management strategies, and maintain long-term financial discipline.
While drawdowns cannot be avoided entirely, careful planning, diversification, and a measured approach to risk can help investors weather market volatility effectively.
Ultimately, understanding drawdowns is not just about avoiding losses; it is about achieving sustainable growth while preserving capital. Monitoring and managing drawdown is a cornerstone of smart, responsible investing.
Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
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