Maximum Drawdown (MDD) Defined, With Device for Calculation

What Is a Maximum Drawdown (MDD)?

A maximum drawdown (MDD) is the maximum spotted loss from a most sensible to a trough of a portfolio, forward of a brand spanking new most sensible is attained. Maximum drawdown is a hallmark of problem probability over a specified period of time.

It can be used each and every as a stand-alone measure or as an input into other metrics similar to “Return over Maximum Drawdown” and the Calmar Ratio. Maximum Drawdown is expressed in percentage words.

The Device for Maximum Drawdown Is


$\begin{array}{c}MDD=\frac{\text{Trough Price}-\text{Most sensible Price}}{\text{Most sensible Price}}\end{array}$

get started{aligned} MDD=frac{textit{Trough Price}-textit{Most sensible Price}}{textit{Most sensible Price}}end{aligned} MDD=Most sensible PriceTrough Price−Most sensible Price​​

Understanding Maximum Drawdown

Maximum drawdown is a decided on measure of drawdown that looks for the most productive movement from a most sensible stage to a low stage, forward of a brand spanking new most sensible is achieved. Alternatively, you should phrase that it only measures the dimensions of the largest loss, without taking into account the frequency of large losses. Because it measures only the largest drawdown, MDD does no longer indicate how long it took an investor to recuperate from the loss, or if the investment even recovered the least bit.

Maximum drawdown (MDD) is a hallmark used to judge the relative riskiness of one stock screening methodology versus some other, as it makes a speciality of capital preservation, which is a key fear for lots of consumers. For instance, two screening strategies will have the equivalent cheap outperformance, tracking error, and volatility, on the other hand their maximum drawdowns compared to the benchmark can be very different.

A low maximum drawdown is hottest as which means that losses from investment have been small. If an investment not at all out of place a penny, the maximum drawdown may well be 0. The worst possible maximum drawdown may well be -100%, which means that the investment is completely worthless.

MDD should be used in the appropriate perspective to derive the maximum have the advantage of it. In this regard, specific attention should be paid to the period of time being regarded as. For instance, a hypothetical long-only U.S. fund Gamma has been in existence since 2000 and had a maximum drawdown of -30% inside the length completing 2010. While this may occasionally seem like a huge loss, phrase that the S&P 500 had plunged more than 55% from its most sensible in October 2007 to its trough in March 2009. While other metrics would need to be regarded as to judge Gamma fund’s overall potency, from the perspective of MDD, it has outperformed its benchmark by way of a huge margin.

Example of Maximum Drawdown

Consider an example to seize the concept of utmost drawdown. Assume an investment portfolio has an initial value of $500,000. The portfolio will build up to $750,000 over a period of time, forward of plunging to $400,000 in a ferocious go through market. It then rebounds to $600,000, forward of shedding all over again to $350,000. Because of this truth, it more than doubles to $800,000. What is the maximum drawdown?


$\begin{array}{cc}& \text{The maximum drawdown in this case is}\end{array}$

get started{aligned}&text{The maximum drawdown in this case is}&qquadquad=frac{$350,000-750,000}{$750,000=-53.33%}end{aligned} ​The maximum drawdown in this case is​

Bear in mind the following problems:

• The initial most sensible of $750,000 is used inside the MDD calculation. The interim most sensible of $600,000 is not used, as it does no longer represent a brand spanking new most sensible.
• The new most sensible of $800,000 may be no longer used since the unique drawdown began from the $750,000 most sensible.
• The MDD calculation takes into account the ground portfolio value ($350,000 in this case) forward of a brand spanking new most sensible is made, and no longer merely the main drop to $400,000.