A 50% loss followed by a 50% gain leaves you down 25%. This arithmetic surprises almost everyone the first time they see it. The asymmetry between losses and recoveries is one of the most practically important facts in all of investing — it's why avoiding large drawdowns matters so much more than chasing large gains.
Maximum drawdown (MDD) is the largest peak-to-trough decline in a portfolio's value over a given period. It answers: what's the worst experience an investor in this strategy has had? A fund that returns 12% annually but has a maximum drawdown of 65% is very different from one returning 10% with a maximum drawdown of 15% — even though the average return looks similar.
The Calmar ratio = annual return ÷ maximum drawdown. It measures how much return you're getting per unit of worst-case drawdown. A strategy returning 15% with a 60% maximum drawdown (Calmar = 0.25) is worse on a risk-adjusted basis than one returning 10% with a 20% maximum drawdown (Calmar = 0.5). The Calmar ratio is often more practically meaningful than the Sharpe ratio for evaluating how comfortable a strategy actually is to hold.
The key insight from recovery maths: a strategy that avoids the worst 10% of outcomes — even at the cost of some upside — often produces better long-term compounded returns than one that captures every gain but suffers the full drawdowns. Volatility drag is real: consistently earning 8% beats averaging 15% one year and -10% the next. Smooth compounds better than volatile.
Answer questions on drawdowns & recovery, earn XP, and challenge your mates to a stock duel.
Download free on iOS →