Reviewed by Gotrade Internal Analyst
If you invest or trade for long enough, you will experience periods where your portfolio goes down before it goes up again. These declines are a normal part of market cycles, but how deep they go matters more than many people realize. This is where the concept of drawdown becomes important.
Understanding drawdown helps you set realistic expectations, manage risk, and avoid emotional decisions during market downturns. It also gives you a clearer picture of how a strategy behaves when things do not go as planned.
This guide explains the drawdown meaning in simple terms, with clear examples and practical context for both investors and traders.
What Is Drawdown?
Drawdown is the percentage decline from a portfolio’s peak value to its lowest point before it recovers to a new high.
In simple terms, drawdown shows how much you lose during a downturn, not just how much you gain during good periods.
Example:
If your portfolio grows from 10,000 dollars to 12,000 dollars, then falls to 9,000 dollars before rising again, the drawdown is measured from the peak of 12,000 dollars to the low of 9,000 dollars.
That is a drawdown of 25 percent.
In simple terms:
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The peak is your highest balance
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The trough is your lowest balance after that peak
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Drawdown measures the drop between the two
How Does Drawdown Work?
Drawdown is usually expressed as a percentage, not a dollar amount. This makes it easier to compare risk across different portfolios or strategies.
1. Identify the peak
This is the highest value your portfolio reaches before a decline begins.
2. Identify the lowest point
This is the lowest value reached before the portfolio starts to recover.
3. Calculate the percentage drop
Drawdown is calculated as the decline from the peak to the lowest point, divided by the peak value.
Drawdown continues until the portfolio fully recovers and reaches a new high. Until that happens, you are still considered to be in a drawdown period.
Drawdown Example in Trading and Investing
Imagine two investors who both start with 10,000 dollars.
Investor A:
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Portfolio rises to 12,000 dollars
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Falls to 11,000 dollars
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Drawdown is about 8.3 percent
Investor B:
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Portfolio rises to 12,000 dollars
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Falls to 8,000 dollars
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Drawdown is about 33.3 percent
Even if both investors end the year with similar returns, Investor B experienced a much deeper drawdown. This usually means higher stress, higher risk, and a greater chance of making emotional decisions.
In drawdown in trading, large drawdowns are often linked to oversized positions, poor risk control, or trading during unfavorable market conditions.
Why Drawdown Matters More Than You Think
Many investors focus only on returns, but drawdown gives important context to those numbers.
It affects your ability to recover
A 10 percent drawdown needs an 11 percent gain to recover. A 50 percent drawdown needs a 100 percent gain just to break even.
It tests emotional discipline
Deep drawdowns make it harder to stick to a plan. This is often when investors panic, sell at the wrong time, or abandon a strategy.
It reveals hidden risk
Two strategies can deliver the same average return, but the one with smaller drawdowns is usually easier to live with and more sustainable over time.
It matters for long-term compounding
Large losses interrupt the compounding process and slow long-term growth, even if future returns are strong.
Drawdown vs Volatility
Drawdown and volatility are related but different.
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Volatility measures how much prices move up and down over time
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Drawdown measures the worst loss from a peak to a low point
A strategy can be volatile but still avoid deep drawdowns. Another strategy may look calm most of the time but suffer rare, severe losses. This is why drawdown is often a more practical risk measure for real investors.
How Investors and Traders Manage Drawdown
There is no way to avoid drawdowns completely, but they can be managed.
Common approaches include:
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Position sizing to limit losses on any single trade
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Diversification across assets and sectors
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Using stop loss rules in active trading
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Keeping realistic expectations about market cycles
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Matching strategy risk to your time horizon
Long-term investors often accept moderate drawdowns in exchange for growth. Active traders usually aim to keep drawdowns smaller to protect capital and stay flexible.
Conclusion
Drawdown measures how much your portfolio falls from its highest point before it recovers. It is one of the clearest ways to understand risk, especially during market downturns.
By paying attention to drawdown, you can choose strategies that fit your risk tolerance, avoid unnecessary stress, and stay invested through normal market ups and downs.
If you want to start building experience while managing risk, you can explore US stocks with small amounts through the Gotrade app. Fractional shares make it easier to learn, stay diversified, and grow your portfolio step by step.
FAQ
What is drawdown in simple terms?
Drawdown is the percentage loss from your portfolio’s highest value to its lowest point before it recovers.
Is drawdown the same as a loss?
Not exactly. A drawdown measures a temporary decline from a peak. A loss becomes permanent only if you sell and lock it in.
What is a good drawdown level?
There is no universal number. Many long-term investors accept drawdowns of 10 to 30 percent, while active traders often aim to keep drawdowns much smaller.
Why is drawdown important in trading?
Large drawdowns increase the risk of emotional mistakes and make it harder to recover.
Reference:
- Investopedia, Drawdown: What It Is, Risks, and Examples, 2026.
- Fidelity, What Is A Drawdown?, 2026.
Disclaimer:
Gotrade is the trading name of Gotrade Securities Inc., which is registered with and supervised by the Labuan Financial Services Authority (LFSA). This content is for educational purposes only and does not constitute financial advice. Always do your own research (DYOR) before investing.
