Maximum drawdown (MDD) is the largest peak-to-trough decline in a portfolio's value over a defined period, from a high point to the lowest subsequent value, usually shown as a percentage or currency.
Investors and portfolio managers use MDD to gauge downside risk and the worst-case experience of a strategy over a chosen horizon. It complements other measures like volatility by focusing on worst-case loss, not on average movement. MDD is sensitive to the lookback period; longer horizons can yield larger drawdowns, while shorter periods may hide bigger declines. It is commonly used in backtests and performance reporting to understand potential losses during downturns.
To compute MDD: identify the highest value (peak) up to each point, track the subsequent lowest value (trough) before a new peak appears, and record the largest drop. The result can be expressed as a percentage of the peak value or in currency terms. MDD does not reflect how quickly the decline occurred (that is the drawdown duration) or recovery time.
MDD is a backward-looking risk measure, not a guarantee of future results. Lower MDD suggests less severe downside in historical periods, but it does not ensure better risk-adjusted future performance. It is often paired with measures like the Calmar Ratio (which relates annualized return to MDD) to assess risk-adjusted performance.
Example: A portfolio peaks at $100 and later drops to $60 before recovering, yielding an MDD of 40%.
Drawdown · Drawdown Duration · Recovery Time · Volatility · Calmar Ratio · Downside Risk