What is “drawdown”?

The drawdown is a risk measure. It represents the loss that an investor would have suffered during a specific period, had he bought at the highest point and sold at the lowest. One can also measure the “current/ongoing drawdown” of an investment. It represents current loss of the investment since the last highest point. We show below the evolution of an asset’s price, along with its current and maximum drawdown:

drawdown example

While the financial industry extensively uses volatility to measure risks, drawdown is a relevant alternative. Indeed, it makes direct sense to an investor to look at his nominal loss. Moreover drawdown gives a better picture of the risk in comparison to volatility (click here for more information).

As Sharpe ratio, which adjusts returns by volatility, MAR ratio is also a risk-adjusted performance measure, which adjusts the returns by downside risk. It is defined as below:

MAR equation

It is possible to limit the drawdown of an investment to a pre-defined level with asset allocation techniques, stop-loss rules or combinations of derivatives. Active Asset Allocation specializes in dynamic asset allocation techniques, and develop advanced solutions such as DARM to help investors to preserve their assets and protect the realized performance.

drawdown limited