What Is Drawdown in Stocks? Measuring Portfolio Losses
Quick Facts
| Term | Meaning |
|---|---|
| Peak-to-trough | Maximum decline from a high point |
| Recovery time | Time to return to the previous peak |
| Maximum drawdown | Worst decline over a given period |
Summary
Drawdown is the percentage decline from a portfolio's peak value to its subsequent low. Maximum drawdown is the worst such decline over a time period. The math of recovery makes drawdowns asymmetric: a 50% loss requires a 100% gain to break even. Understanding drawdown helps investors prepare for inevitable market declines.
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The Concept Explained Simply
Every investor will experience drawdowns. The S&P 500 has had drawdowns of 10% or more roughly once per year on average throughout its history. Drawdowns of 20% or more (bear markets) happen roughly every 3–4 years. Drawdowns of 30% or more are rarer but have occurred in 2000–2002, 2008–2009, and briefly in 2020.
A drawdown is measured from peak to trough, not from your original investment. If you invested $80,000, your portfolio grew to $120,000, then fell to $90,000, your drawdown is 25% (from $120,000 to $90,000), even though you are still above your initial investment.
Maximum drawdown (often abbreviated "Max DD") is the most important drawdown metric. It tells you the worst peak-to-trough decline your portfolio (or a stock, or an index) has experienced over a given time period. Historically, the S&P 500’s maximum drawdown was about 57% during the 2008–2009 financial crisis.
What makes drawdown particularly important is the math of recovery. A 10% drawdown requires an 11% gain to break even. A 25% drawdown requires a 33% gain. A 50% drawdown requires a 100% gain just to get back to where you were. This asymmetry means that large drawdowns are disproportionately damaging, and avoiding or reducing them has an outsized impact on long-term returns.
Why It Matters For Beginners
Drawdown is the most tangible risk metric for beginners because it answers the most human question in investing: "How much could I lose?"
Abstract risk measures like standard deviation and beta are useful but can feel disconnected from real-world experience. A 30% drawdown on a $200,000 portfolio means watching $60,000 disappear. That is visceral. That is the moment when most investors make their worst decisions.
Understanding your portfolio’s historical maximum drawdown helps you set realistic expectations. If your holdings experienced a 45% drawdown during the 2008 crisis, a similar event in the future would not come as a complete shock. You would have already decided, in advance, how you would respond.
Drawdown also helps with portfolio construction. If you know that you cannot psychologically tolerate a drawdown larger than 20%, you need to build a portfolio with characteristics that have historically kept drawdowns below that level. This might mean including bonds, low-volatility stocks, or non-correlated asset classes.
The most expensive mistakes in investing happen during drawdowns: selling at the bottom, abandoning a sound strategy, or switching to cash and missing the recovery. Understanding drawdown does not prevent losses. It prevents panic.
Common Misunderstandings
Drawdowns are normal. Every stock and every portfolio experiences them. The S&P 500 has had dozens of 10%+ drawdowns while still delivering strong long-term returns.
A drawdown is a temporary decline from a peak. It only becomes a permanent loss if you sell at the bottom. Many drawdowns fully recover within months or years.
Frequent small drawdowns (5–10%) are important because they reveal how volatile your portfolio is day to day. They also compound if they happen repeatedly without recovery.
No investor avoids drawdowns entirely. Even the most successful portfolio managers experience them. The difference is they have a plan for how to respond, rather than reacting emotionally.
Mini Checklist
- I understand that drawdown measures the decline from a portfolio peak to a trough
- I know the difference between drawdown and permanent loss
- I have checked the maximum historical drawdown of my largest holdings
- I understand the recovery math (50% loss requires 100% gain to break even)
- I have considered my personal maximum tolerable drawdown in dollar terms
- I know that the S&P 500 averages a 10%+ drawdown roughly once per year
- I have a written plan for what I will do during a 20%+ drawdown
- I understand that selling during a drawdown locks in losses
- I have tested my portfolio against historical crash scenarios
Frequently Asked Questions
What is maximum drawdown?
Maximum drawdown is the largest peak-to-trough percentage decline that a portfolio or investment has experienced over a specific time period. It represents the worst-case historical loss.
How do I calculate drawdown?
Drawdown = (Peak Value - Trough Value) / Peak Value x 100. If your portfolio peaked at $100,000 and dropped to $75,000, your drawdown is 25%.
What is a normal drawdown for a stock portfolio?
A diversified stock portfolio might experience drawdowns of 10–15% during normal market corrections and 25–50% during severe bear markets. The exact range depends on your holdings.
How long do drawdowns typically last?
Most 10% drawdowns recover within a few months. Bear market drawdowns (20%+) historically take 1–3 years to fully recover. The 2008 drawdown took about 5.5 years for the S&P 500 to recover.
Can I reduce my portfolio’s maximum drawdown?
Yes. Adding bonds, low-correlation assets, and reducing concentration in high-beta stocks are all strategies that historically reduce maximum drawdown, though they may also reduce return potential.
Should I sell during a drawdown?
In most cases, selling during a drawdown locks in losses. If your investment thesis is still intact and your time horizon is long, staying invested (or even adding) during drawdowns has historically produced better outcomes than selling.
What is drawdown recovery time?
Drawdown recovery time is the number of days, months, or years it takes for a portfolio to return to its previous peak after a drawdown. Deeper drawdowns generally require longer recovery times.
What is the difference between drawdown and correction?
A correction is specifically a 10-20% decline from a recent high in a market index. Drawdown is a broader term that applies to any decline from a peak to a trough in any investment or portfolio, regardless of the percentage.
Verdict
Drawdown is where investing theory meets emotional reality. Every portfolio will experience declines. The question is not whether it will happen, but whether you are prepared when it does. Know your historical maximum drawdown, decide in advance what you will do, and you will avoid the most common and costly mistake in investing: selling at the bottom.
How Stock Expert AI Helps
Stock Expert AI helps you understand drawdown through the Time Machine feature, which shows how your current holdings would have performed during historical market crashes (2008, COVID, 2022). The AI Portfolio Scanner identifies which positions contribute the most to potential drawdown risk. All results are presented in dollar terms and plain language so you understand exactly what a drawdown would mean for your specific portfolio.
Want to see your portfolio’s drawdown risk? Try the Time Machine or upload your holdings for analysis.
Explore the full guide map: Portfolio Risk Guide
Evidence & Sources
- Data sources used on Stock Expert AI include FMP (Financial Modeling Prep), Alpaca, Finnhub, Alpha Vantage, and SEC filings where available.
- Definitions follow standard investing terminology; each page explains concepts in beginner-friendly language.
- Financial data is refreshed regularly from real-time and delayed market feeds.
- This page is educational and does not constitute investment advice.
- All analysis is generated by AI models and should be verified with independent research.
This is not financial advice.