What Is Max Drawdown? | Max drawdown is the largest loss an investment experiences over a specific period, measured from its highest point to its lowest point. | Here's how it works: | If a stock hits $100, crashes to $50, and then climbs back to $80, your current position may be down 20%, but the max drawdown was 50%. In simple terms, max drawdown represents the maximum damage a stock has historically inflicted on a portfolio. | Max drawdown matters because it is one of the few metrics that quantifies endurance.
Returns measure performance. Max drawdown measures survivability. |
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| | How Institutions Use Max Drawdown as Entry Points | Retail investors see max drawdown as a scary number. Institutional investors see it as a roadmap. | Portfolio managers use max drawdown to: | Size positions based on worst-case loss scenarios. Compare risk-adjusted returns (a 15% return with a -20% drawdown beats a 15% return with a -50% drawdown). Identify defensive versus aggressive holdings for asset allocation.
| When a stock declines, analysts compare current conditions to prior crises. If fundamentals are similar or better, the previous max drawdown becomes a natural buy zone. Why? Because investors remember: "At -40%, this was considered oversold, and buyers stepped in." | If a stock approaches its historical -40% drawdown, institutional traders look for: | Slowing downside momentum. Volume spikes on down days followed by lighter volume. Stabilization near the prior low.
| If these signals align, the max drawdown level can become a tactical long entry, with a tight stop below the historical low. |
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| | S&P 500 Max Drawdowns (Last 10 Years) | Below are S&P 500 stocks with the lowest recorded max drawdowns from January 2016 to January 2026. | Top 10 S&P 500 Stocks by Lowest Max Drawdown (2016–2026) | | These are defensive stalwarts—utilities, healthcare, and consumer staples. Their shallow drawdowns make them suitable during market downturns. | Top 10 S&P 500 Stocks by Highest Max Drawdown (2016–2026) | | These are growth and cyclical stocks such as energy, entertainment, and fintech. A worst-case loss of -93% highlights how risky growth stocks can be. |
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| | What This Means for Positioning | Defensive stocks (max drawdown < -25%) help protect capital during market stress. They may underperform in bull markets, but they preserve wealth during corrections. | Use them for: | | Growth stocks (max drawdown > -50%) amplify gains in bull markets but can destroy capital in corrections. | Use them for: | Tactical investments with strict stop-losses. Bull-market momentum plays. Small allocation sizes you can afford to lose.
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| | How to Use Max Drawdown in Portfolio Construction | Set portfolio-level drawdown tolerance.
If you can't stomach a -30% portfolio decline, your holdings should average max drawdowns of -20% to -25%, not -60% to -80%. You can evaluate this using a portfolio visualizer tool. Size positions based on drawdown risk.
Higher max drawdown = smaller position size.
Example: Rebalance as drawdowns approach.
When a holding nears its historical max drawdown, consider adding if fundamentals remain intact. When it trades near all-time highs, consider trimming. Build a barbell strategy.
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| | The Bottom Line | Max drawdown is the ultimate measure of portfolio risk because it reflects the real pain you'll experience—not hypothetical volatility. | The best portfolio isn't the one with the highest returns. It's the one you can stick with through the worst drawdowns without panicking. | Know your max drawdown tolerance. Build your portfolio accordingly. The capital you preserve during corrections compounds far more than the upside you miss chasing growth stocks with -85% drawdowns. |
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| | | | | Important disclosures: This newsletter is provided for informational purposes only and does not constitute investment advice. All investments involve risk, including possible loss of principal. Please consult with your financial advisor before making investment decisions. |
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