What Is Maximum Drawdown? How to Measure a Strategy's Worst Period

What is maximum drawdown?

Maximum drawdown is the largest loss in value from a peak in an account or strategy. For example, if an account fell from 100,000 to 70,000 and then recovered, the maximum drawdown is 30%. It answers the question: "how much did it lose in the worst case?"

How is it calculated?

1. Track the highest value the account has reached (the peak).
2. At every point, calculate the percentage loss from that peak.
3. The largest of those percentages is the maximum drawdown.

Why does it matter?

• Return alone is meaningless. A strategy that made 50% but dropped 60% along the way is more than most people can live with.
• Losses are asymmetric. After a 50% fall you need a 100% gain to get back to even.
• It shows your psychological limit. Could you actually sit through that drop?

Recovery time

Besides the size of the drop, how long it took to recover matters. A drawdown that lasts months ties up your capital.

Common mistakes

1. Looking at return only: Always read drawdown together with return. See What is the Sharpe ratio?
2. A short test period: Short data may not include the real worst period.
3. Treating the past worst case as a ceiling: A future drawdown can be larger than any in the past.
4. Forgetting leverage: Leverage magnifies drawdown. See Leverage and liquidation risk.

How it relates to risk rules

To limit drawdown, set position sizes and loss limits. See the Algo trading risk management guide.

This article is educational and not investment advice. Past results do not guarantee future results; trading carries a risk of loss.