Drawdown and Maximum Drawdown
2 min read
A drawdown refers as a peak-to-trough decline during a selected period for an investment, trading account, or fund. A drawdown is typically quoted because the percentage between the height and therefore the subsequent trough. If a trading account has $10,000 in it, and therefore the funds drop to $9,000 before moving back above $10,000, then the trading account witnessed a tenth drawdown.
Drawdowns are important for measuring the historical risk of various investments, comparing fund performance, or monitoring personal trading performance.
- A drawdown refers to what proportion an investment or trading account is down from the height before it recovers back to the height .
- Drawdowns are typically quoted as a percentage, but dollar terms can also be used if applicable for a selected trader.
- Drawdowns are a measure of downside volatility.
- The time it takes to recover a drawdown should even be considered when assessing drawdowns.
A drawdown and loss aren’t necessarily an equivalent thing. Most traders view a drawdown as a peak-to-trough metric, while losses typically ask the acquisition price relative to the present or exit price.
A maximum drawdown (MDD) is that the maximum observed loss from a peak to a trough of a portfolio, before a replacement peak is attained. Maximum drawdown is an indicator of downside risk over a specified period of time .
It are often used both as a stand-alone measure or as an input into other metrics like Return over Maximum Drawdown and therefore the Calmar Ratio. Maximum Drawdown is expressed in percentage terms.
Maximum drawdown defines as a specific measure of drawdown that appears for the best movement from a part to a coffee point, before a replacement peak is achieved. However, it is vital to notice that it only measures the dimensions of the most important loss, without taking into consideration the frequency of huge losses. Because it measures only the most important drawdown, MDD doesn’t indicate how long it took an investor to get over the loss, or if the investment even recovered in the least.
The formula of Maximum Drawdown is:
MDD= (Trough Value – Peak Value) / Peak Value
