A drawdown measures how far a portfolio has fallen from its most recent peak at any point in time. If a portfolio was worth $100 at its high and is now worth $75, it is in a 25% drawdown. Drawdowns are expressed as percentages and tracked continuously; the drawdown counter resets only when the portfolio sets a new all-time high.
Drawdown is the most psychologically powerful performance metric because it directly captures the experience of loss. A strategy that earns 10% annually but passes through a 50% drawdown along the way will be abandoned by most investors before they collect the gains. This behavioural reality is why drawdown management — not just return maximisation — is central to any honest evaluation of timing strategies.
The asymmetry of losses is critical: a 50% drawdown requires a 100% gain just to recover. That mathematical reality is why deep drawdowns are so destructive to compounding. Market timers who exit to reduce drawdowns must also make a correct re-entry decision — and the cost of mistiming the exit, the re-entry, or both frequently exceeds the cost of the drawdown itself.