Definition
Drawdown is the percentage decline of an investment, account or strategy from its previous peak value to a later low. Maximum drawdown is the largest such peak-to-trough fall over a chosen period.
How it works
Drawdown is measured at every point as current value divided by the highest value reached so far, minus one, so it is always zero or negative. The time from a peak until a new peak is the drawdown duration, which can matter as much as depth because it shows how long capital stayed below its high.
Recovery is nonlinear: after a loss of d, the gain needed to return to the old peak is d ÷ (1 − d). A 10% fall needs +11.1%, a 20% fall needs +25%, a 50% fall needs +100%, and an 80% fall needs +400%.
Formula / convention
Drawdown(t) = (Value(t) − Peak(t)) ÷ Peak(t), where Peak(t) is the highest value up to time t; Gain needed to recover = d ÷ (1 − d), where d is the drawdown as a positive fraction
Illustrative example
Illustrative: a fictional portfolio rises to HK$200,000, then falls to HK$120,000. The drawdown is (120,000 − 200,000) ÷ 200,000 = −40%, and returning to HK$200,000 requires 200,000 ÷ 120,000 − 1 = +66.7%, not +40%.
What to watch for
Maximum drawdown belongs to the sample period; a longer or different history can contain a worse one, so past maximum drawdown is not an upper limit. Deep drawdowns can also force exits, for example when leveraged positions are liquidated, before any recovery occurs.