What Is Max Drawdown? The Number That Tells You If You Can Stomach a Strategy
Max drawdown is the largest peak-to-trough drop in your portfolio value. It answers: "What's the worst it's ever gotten?"
The Formula
Max Drawdown = (Trough Value - Peak Value) / Peak Value
Example: Your portfolio peaks at $150,000, then drops to $127,110 before recovering.
Max Drawdown = (127,110 - 150,000) / 150,000 = -15.26%
Why It Matters More Than You Think
Every strategy looks great on a returns chart. But returns don't tell you what it felt like to trade it.
A 15% drawdown means watching $15,000 of every $100,000 disappear — with no guarantee it'll come back. A 30% drawdown means $30,000 gone. A 50% drawdown means you need a 100% gain just to break even.
| Max Drawdown | Gain Needed to Recover |
|---|---|
| 10% | 11.1% |
| 20% | 25.0% |
| 30% | 42.9% |
| 50% | 100.0% |
| 75% | 300.0% |
The math gets ugly fast. This is why drawdown matters more than return for most traders — it determines whether you'll actually stick with the strategy.
What's Acceptable?
It depends on the strategy type:
| Strategy | Typical Max Drawdown |
|---|---|
| Mean reversion (ETFs) | 10–20% |
| Trend following | 20–40% |
| Buy and hold S&P 500 | ~55% (2008) |
| Individual stocks | 30–60% |
Generally, if you think your max drawdown tolerance is 20%, it's probably 10% in practice. Backtests don't capture the psychological pain of watching your money evaporate in real time.
Drawdown Duration Matters Too
A 15% drawdown that recovers in 2 weeks is very different from one that takes 18 months. When evaluating strategies, check both the depth and duration of the worst drawdown.
Key Takeaway
Max drawdown is the reality check for any backtest. A strategy that makes 20% a year but drops 50% along the way will be abandoned by most traders before it pays off. Always check drawdown first — if you can't survive it, the returns don't matter.