Definition
Maximum drawdown is the single worst peak-to-trough loss experienced by a portfolio. It represents the worst timing scenario—investing at the peak and selling at the subsequent trough. Max DD is particularly important for leveraged strategies where large drawdowns can trigger margin calls and force liquidation at the worst possible time.
functions Formula
Max DD = max[(Peak_i − Trough_i) / Peak_i]
lightbulb Example
Over 10 years, a portfolio had drawdowns of -15%, -8%, -32%, and -12%. Maximum drawdown = 32%. The S&P 500 experienced a 50%+ max drawdown during the 2008 financial crisis.
verified_user Key Points
- Worst possible entry-to-exit return
- Leverage amplifies max drawdown
- 2008 S&P 500 max DD exceeded 50%
- Calmar ratio = annual return / max drawdown