Drawdown

Drawdown measures how much an asset, portfolio, or strategy falls from its previous peak.

It answers a question that price and returns alone cannot:

How painful was the worst decline along the way?

In volatile markets like crypto, drawdowns often matter more than final returns.

What drawdown represents

A drawdown is the decline from a local peak to a subsequent trough, measured before a new peak is reached.

It is usually expressed as a percentage.

Example:

• Peak value: $100
• Trough value: $60
  → Drawdown: −40%

Drawdowns describe path risk, not end results.

Maximum drawdown explained

Maximum drawdown is the largest peak-to-trough decline over a given period.

It represents:

• the worst loss an investor would have experienced
• the maximum psychological and capital stress point
• the deepest hole that had to be recovered from

Maximum drawdown ignores how fast recovery happened — only depth matters.

Drawdown vs volatility

Drawdown and volatility are related but different.

• Volatility measures how much prices fluctuate
• Drawdown measures how bad the worst decline was

An asset can:

• have high volatility but shallow drawdowns
• have low volatility but one severe drawdown

Drawdown captures tail pain, not noise.

Why drawdowns matter more than returns

Large drawdowns create structural problems:

• they require disproportionately larger gains to recover
• they increase emotional pressure and decision errors
• they raise the risk of selling at the worst possible time

A −50% drawdown requires a +100% gain just to break even.

Drawdown asymmetry and recovery math

Losses and gains are asymmetric.

This asymmetry is why drawdown control matters even for long-term investors.

Drawdowns in crypto markets

Crypto assets routinely experience:

• drawdowns of 50–80%
• multi-year recovery periods
• repeated deep declines even in secular bull markets

This makes drawdown awareness essential when:

• comparing assets
• evaluating strategies
• sizing positions
• deciding on leverage or stops

Drawdown vs risk management tools

Different tools interact with drawdowns differently:

• Stop losses can cap drawdowns but increase exit frequency
• DCA can reduce timing risk but not eliminate drawdowns
• Trimming can reduce drawdown depth at the cost of upside
• Diversification can smooth drawdowns but not remove them

No tool removes drawdowns entirely — they only reshape them.

Common misconceptions

“Maximum drawdown tells me future risk”

False.

It only describes historical worst-case, not future guarantees.

“Lower drawdown means better strategy”

Not always.

Lower drawdown often comes with:

• lower upside
• lower participation
• different risk trade-offs

“I can ignore drawdowns if I hold long enough”

Psychologically and structurally dangerous.

Most investors abandon strategies during drawdowns, not at peaks.

When drawdown analysis is most useful

Drawdown analysis is most useful when:

• comparing strategies or assets
• evaluating risk tolerance
• stress-testing assumptions
• deciding position sizing
• understanding path dependency

When drawdown analysis is misleading

Drawdown analysis breaks down when:

• used without return context
• treated as a single decision metric
• ignored in favor of peak-to-peak charts
• applied without understanding volatility regimes

Key takeaway

Drawdown measures how deep the pain went, not how good the ending looks.

• Returns tell you where you finished
• Drawdowns tell you whether you could survive the journey
• In crypto, drawdowns are structural — not anomalies

Understanding drawdown is a prerequisite for understanding risk.