Definition
Maximum Drawdown
Maximum drawdown is the largest peak-to-trough decline in the value of a portfolio or strategy over a period, measuring the worst loss an investor would have suffered before a new high was reached.
For Indian quant and systematic strategies, maximum drawdown is often a more visceral risk measure than volatility because it captures the real pain of holding through a losing streak. A strategy with a high Sharpe ratio but a 50% drawdown may be psychologically and operationally untenable.
Drawdown analysis pairs naturally with Monte Carlo simulation, which estimates the distribution of likely drawdowns beyond the single historical path. Recovery time, the duration to claw back to the prior peak, is an equally important companion metric for assessing whether a strategy is investable.
Related terms
- BacktestingBacktesting is the process of simulating a trading strategy on historical data to estimate how it would have performed, including returns, drawdowns and risk, before committing real capital.
- Sharpe Ratio OptimisationSharpe ratio optimisation is the process of constructing or tuning a portfolio or strategy to maximise return per unit of risk, measured as excess return divided by volatility.
- Risk ParityRisk parity is a portfolio construction approach that allocates capital so that each asset or asset class contributes equally to total portfolio risk, rather than weighting by capital invested.
- Monte Carlo SimulationMonte Carlo simulation is a technique that runs thousands of randomised scenarios to model the range of possible outcomes for a strategy or portfolio, revealing the distribution of returns, drawdowns and risk.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.