Lesson 8 of 20 · 6 min
Drawdown versus volatility
Drawdown measures the worst peak-to-trough fall, which is what thresholds actually respond to.
If volatility is the wrong summary for a leveraged holder, drawdown is much closer to the right one.
Drawdown is the decline from a peak to the subsequent trough, expressed as a percentage of the peak. Maximum drawdown is the worst such decline over a period. Unlike volatility it is directional, it is path-based, and it is measured in the same units as a maintenance threshold — which is why it is the statistic that maps onto a trigger level.
The two can diverge substantially. A portfolio that alternates plus three and minus three percent daily has high volatility and small drawdowns, because the declines never accumulate. A portfolio that drifts downward by half a percent a day for four months has low volatility and a 35 percent drawdown. A threshold cares about the second one; a volatility figure barely notices it.
Two properties of drawdown deserve attention. Recovery is asymmetric: a 50 percent drawdown requires a 100 percent gain to return to the peak, because the gain is computed on the smaller base. And drawdown is measured at the trough, meaning it captures the moment of maximum stress rather than the endpoint — which is exactly the moment a lender's threshold test runs.
For anyone with a pledged portfolio, this points to a single number worth knowing: the drawdown that reaches your trigger value. Everything else about the distribution is context around that one figure.
Key terms
- Drawdown
- The percentage decline from a peak to a subsequent trough. Directional and path-based.
- Maximum drawdown
- The largest such decline over a stated period. The usual summary of worst-case experienced pain.
- Recovery asymmetry
- The fact that recovering from a decline requires a larger percentage gain than the decline itself, because the base is smaller.
Worked example
Recovery asymmetry, and the drawdown that matters
A $600,000 portfolio with a $300,000 balance and a 70% threshold. Trigger value $428,571.
- Drawdown that reaches the trigger
- 28.6%
- 10% drawdown
- Recovery needed: 11.1%
- 28.6% drawdown
- Recovery needed: 40.0%
- 50% drawdown
- Recovery needed: 100.0%
- Volatility figure for all cases
- Unchanged
- The one number to know
- 28.6%
Drawdown and volatility are different statistics.
The threshold is a drawdown level, not a volatility level. Recovery from it requires a 40 percent gain, which is why crossing it is not symmetric with approaching it.
Check yourself
A portfolio falls 50% from its peak. What gain is required to return to the peak, and why is drawdown a better summary than volatility for a pledged portfolio?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.