Maximum Drawdown
In short
Largest peak-to-trough decline — worst case historical loss
If your portfolio hit $10,000 then fell to $6,000 before recovering, the max drawdown is 40%. It measures the worst experience a real investor would have endured.
Maximum drawdown measures the largest peak-to-trough decline before a new high is reached. It's the key metric for understanding tail risk and investor pain. Strategies with similar returns can have drastically different max drawdowns.
Formula
MDD = (Trough Value - Peak Value) ÷ Peak Value × 100Thresholds
- 0 to -10
- Minimal drawdown
- -10 to -20
- Moderate
- -20 to -40
- Significant — tests conviction
- < -40
- Severe — most investors quit
Related concepts
- Value at Risk (VaR 95%) — VaR 95% says: 'On 95% of days, you won't lose more than X.' If your portfolio's daily VaR is $1,000, there's only a 5% chance of losing more than $1,000 in a single day.
- Calmar Ratio — Calmar asks how much return you earned per dollar of maximum pain. If a portfolio returned 15% annually over the period measured but suffered a 30% drop from peak to trough at its worst point, the Calmar ratio is 0.5 — half a percent of return for every percent of that worst loss.
- Sharpe Ratio — Sharpe ratio measures how much return you get for every unit of risk you take. A Sharpe of 1.0 means for every 1% of risk, you earn 1% return above the risk-free rate. Higher is better.
- Portfolio Volatility — Portfolio volatility measures how much your combined investments bounce around. Unlike individual stock volatility, it accounts for diversification — when some holdings go up while others go down, they partially cancel out, reducing overall portfolio risk.