Definition
Maximum drawdown
Maximum drawdown is the largest peak-to-trough decline in account equity. Definition, formula, the asymmetric recovery arithmetic, and how the figure gets misread.
Maximum drawdown is the largest percentage decline from an equity peak to a subsequent trough before a new peak is set. It measures the worst loss a strategy has actually inflicted, not the loss it might inflict, and it is asymmetric: recovering a 50% drawdown requires a 100% gain, which is why drawdown control matters more to compounding than peak return does.
- Also known as
- MDD · peak-to-trough decline
How it is calculated
Drawdown(t) = (Peak equity up to t − Equity(t)) ÷ Peak equity up to t
Max drawdown = max over all t of Drawdown(t)
Recovery required = 1 ÷ (1 − Max drawdown) − 1
Worked example: Equity peaks at $100,000 and falls to $70,000 → 30% max drawdown, requiring a 42.9% gain to recover.
Why it is the constraint, not the statistic
Return is what a strategy produces; drawdown is what a person has to sit through to receive it. Almost every abandoned strategy was abandoned inside a drawdown that the backtest showed and the trader had not internalised. Sizing decisions are therefore made against drawdown tolerance, not against expected return — a strategy that cannot be held is worth zero regardless of its average.
Depth is only half of it
Two strategies with identical 30% maximum drawdowns are not equally survivable if one recovers in six weeks and the other takes two years. Drawdown duration — time under water — is what determines whether capital is available for other opportunities and whether the operator keeps going. Report both, or the number is incomplete.
How it gets misread
Backtested maximum drawdown is routinely treated as a worst case. It is the worst case in the sample, which is a lower bound: the future contains regimes the sample did not. Live drawdowns exceeding the backtested maximum are normal, not evidence of a broken strategy.
Sources
- On the Maximum Drawdown of a Brownian Motion — Journal of Applied Probability (author copy, Rensselaer Polytechnic Institute)
- Drawdown: From Practice to Theory and Back Again — arXiv (Goldberg & Mahmoud; published in Mathematics and Financial Economics)
- Drawdown Measure in Portfolio Optimization — International Journal of Theoretical and Applied Finance (author copy, Columbia University)
Definitions are educational. Nothing here is investment advice, and no metric described on this page predicts future results.
Definitions are the easy part
Knowing what drawdown means is not the same as having a system that halts on it. QANTERION applies these limits while a strategy runs.