Maximum Drawdown Calculator

This maximum drawdown calculator is a wise tool that indicates the risk of an asset, an investment, or a portfolio by measuring how much CAGR difference there is between a maximum peak value and a subsequent lowest value. In this article, we will cover:

• The definition of maximum drawdown;
• How to calculate the maximum drawdown;
• What investors think about it; and
• Real-life examples of maximum drawdown.

The maximum drawdown is a financial indicator that shows how much the value of an investment has lost from its last peak or maximum value. It is expressed as a percentage.

Investors and financial analysts consider it when building portfolios because the maximum drawdown hints about future risk. They compute the future expected stock returns based on the historical returns. Yes, indeed! The future is projected based on past information.

In the beta stock calculator, we used the covariance and variance formula of past returns to indicate asset volatility versus the market. Furthermore, the capital asset pricing model uses a stock's beta to calculate future returns. Hence, you can see that in finance, the future is considered to be similar to the past.

From that point of view, and considering the symmetric normal distribution of returns given a stock:

We can deduce that large drawdowns (long-tail events) happen as well as large upsides. Both situations can happen again in the future. Thus, to minimize that risk, investors optimize the portfolio with tools like sharpe ratio.

For example, consider having 50% of the portfolio in a stock that falls 50% in value. Recovering after such loss could take years which will also have an intrinsic cost, the time value of money.

We've discussed the definition of maximum drawdown, so it's high time we told you how it's actually computed. The maximum drawdown formula is quite simple:

• MD = (LP - PV) / PV × 100%

where:

• MD – Maximum drawdown, in percent;
• LP – Lowest value after peak value; and
• PV – Peak value.

Let's evaluate the maximum drawdown of the S&P500 index ETF, the SPY, and compare it to the most famous cryptocurrency, Bitcoin. You can verify both results in our maximum drawdown calculator.

For the SPY, we have the biggest drawdown to be around March 2020, when the OMS declared COVID-19 a pandemic disease. There we saw:

SPY peak value = 276.21

SPY lowest value after peak value = 222.83

Therefore, SPY maximum drawdown = -19.33%

On the other hand, Bitcoin experienced its maximum drawdown during December 2017 and December 2018. There we had:

BTC peak value = 19252.96

BTC lowest value after peak value = 3178.62

So, BTC maximum drawdown = -83.49%

Because the maximum drawdown of BTC is more significant (over four times), we can state that BTC involves much more risk than SPY. Consequently, asset allocation should be lower when building a portfolio for a more risk-averse investor.

The required recovery time depends on the compound annual growth rate at which the investment price will increase. See the compound growth calculator.

In our maximum drawdown calculator, we have included a feature to add the growth rate (CAGR) and see how many years it will take to recover after a loss. Click on the "Time for recovery" heading to open it. For example, a drawdown of 50% will require five years to break even at a CAGR of 15%.

The best way to reduce the recovery time is to reduce the maximum drawdown event probability. While it is not an easy task, the [free cash flow margin calculator] can help you find suitable investments. Besides, buying the stock at a fair price or below the fair price calculated by the discounted cash flow model can also reduce the investment risk.