Maximum Drawdown (MDD)
What Is a Maximum Drawdown (MDD)?
A maximum drawdown (MDD) is the maximum noticed loss from a top to a trough of a portfolio, before another pinnacle is attained. Maximum drawdown is an indicator of downside risk throughout a predetermined time span.
It very well may be utilized both as an independent measure or as a contribution to different metrics, for example, "Return over Maximum Drawdown" and the Calmar Ratio. Maximum Drawdown is communicated in percentage terms.
The Formula for Maximum Drawdown Is
Grasping Maximum Drawdown
Maximum drawdown is a specific measure of drawdown that searches for the best movement from a high point to a low point, before another pinnacle is accomplished. Nonetheless, it's important to note that it just measures the size of the largest loss, without thinking about the frequency of large losses. Since it measures hands down the largest drawdown, MDD doesn't demonstrate how long it required for an investor to recuperate from the loss, or on the other hand assuming the investment even recuperated by any means.
Maximum drawdown (MDD) is an indicator used to evaluate the relative riskiness of one stock screening strategy versus another, as it centers around capital preservation, which is a key concern for most investors. For instance, two screening strategies can have a similar average outperformance, tracking mistake, and volatility, yet their maximum drawdowns contrasted with the benchmark can be totally different.
A low maximum drawdown is preferred as this shows that losses from investment were small. On the off chance that an investment never lost a penny, the maximum drawdown would be zero. The absolute worst maximum drawdown would be - 100 percent, it is totally worthless to mean the investment.
MDD ought to be utilized in the right viewpoint to get the maximum benefit from it. In such manner, specific consideration ought to be paid to the time span being thought of. For example, a speculative long-just U.S. fund Gamma has been in presence starting around 2000 and had a maximum drawdown of - 30% in the period ending 2010. While this might appear to be a tremendous loss, note that the S&P 500 had plunged over 55% from its top in October 2007 to its trough in March 2009. While different metrics would should be considered to survey Gamma fund's overall performance, from the viewpoint of MDD, it has outflanked its benchmark overwhelmingly.
Illustration of Maximum Drawdown
Consider a guide to comprehend the concept of maximum drawdown. Expect an investment portfolio has an initial value of $500,000. The portfolio increments to $750,000 throughout some undefined time frame, before plunging to $400,000 in a brutal bear market. It then, at that point, bounce back to $600,000, before dropping again to $350,000. Along these lines, it dramatically increases to $800,000. What is the maximum drawdown?
Note the following points:
- The initial pinnacle of $750,000 is utilized in the MDD calculation. The interim pinnacle of $600,000 isn't utilized, since it doesn't address another high.
- The new pinnacle of $800,000 is additionally not utilized since the original drawdown started from the $750,000 top.
- The MDD calculation thinks about the lowest portfolio value ($350,000 in this case) before another pinnacle is made, and in addition to the principal drop to $400,000.
Highlights
- Maximum drawdown (MDD) is a measure of a resource's largest price drop from a top to a trough.
- Maximum drawdown is viewed as an indicator of downside risk, with large MDDs proposing that down movements could be unpredictable.
- While MDD measures the largest loss, it doesn't account for the frequency of losses, not the size of any gains.
