Maximum Drawdown
The largest peak-to-trough decline in portfolio value. Shows worst-case loss scenario.
What it means
Maximum drawdown (MDD) measures the largest peak-to-trough decline in portfolio value before a new peak is reached. It answers: 'What's the worst loss I would have experienced if I bought at the peak and sold at the bottom?'
The math
Calculated by finding the highest point, then the lowest point after that peak, and measuring the percentage decline.
How to read it
- < 10%Conservative - limited downside risk
- 10% - 20%Moderate - normal stock market exposure
- 20% - 40%Aggressive - significant drawdowns expected
- > 40%Very aggressive - extreme volatility, not for all investors
Worked example
If your portfolio peaked at $100,000, then fell to $65,000 before recovering, your max drawdown is 35%. This is the emotional and financial pain point you would have experienced.
In context
Max drawdown is often cited as the most psychologically important risk metric. A portfolio with great average returns but 60% drawdowns will cause most investors to panic-sell at the worst time. Know your drawdown tolerance before investing.
Common mistakes to avoid
- Underestimating how drawdowns feel in real time
- Not considering recovery time along with drawdown depth
- Ignoring that future drawdowns could exceed historical ones
Keep exploring
Value at Risk (VaR)
Estimates the maximum potential loss over a time period at a given confidence level (e.g., 95%).
Standard Deviation
A measure of how spread out returns are from the average. Higher means more volatile.
Sortino Ratio
A variation of Sharpe ratio that only penalizes downside volatility, not upside gains.
Sharpe Ratio
A measure of risk-adjusted return that compares excess return to volatility. Higher is better.
Downside Deviation (D*)
Measures volatility of returns below a target rate using semivariance. Lower values indicate less downside risk.
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