Drawdown is a risk measure that shows how deep an asset or portfolio has fallen from its maximum and how long it has taken to recover.
It takes the form of a percentage between a peak and a trough. If the portfolio's value plunges from $10,000 to $8,000 before returning to the original value, it means it had had a 20% drawdown.
Drawdowns are vital in calculating individual investments' historical risks, comparing various funds, or gauging one's trading performance.
What drawdowns can tell you
Drawdown helps assess whether a particular asset is in line with your investment horizon or not and helps you prepare emotionally and financially to handle the downside risks.
The drawdown of 20%-30% may not be a problem when you are early in your career as your investment has enough time to recover. However, if you are retiring and plan to withdraw funds from your portfolio, you might want lower drawdown risks. You can do it by diversifying your portfolio and choosing assets with lower risk.
Other tools that can help you in assessing risks are Value-at-Risk and Expected Shortfall.
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The Drawdowns chart displays portfolio losses from any high point along the way.