The drawdown is a measurement of a single consecutive loss from peak-to-trough, or in other words, a drawdown begins when a downturn begins and ends when an uptick is recorded.
Maximum drawdown shown in any strategy is the greatest loss from peak-to-trough incurred by the strategy during a selected time period (month by month).
The maximum drawdown formula
Max drawdown metric is generally calculated as such:
Drawdown 1 = (Equity at the end of the drawdown 1 - Equity before the drawdown 1 )/ Equity before the drawdown 1
Drawdown 2 = (Equity at the end of the drawdown 2 - Equity before the drawdown 2 )/ Equity before the drawdown 2
Get maximum from Drawdown 1 and Drawdown 2
An example of maximum drawdown
Let’s take a look at this formula in action:
The vertical metric shows strategy balance, while the horizontal metric shows the steps outlined below.
- A strategy had a starting balance of USD 1 000.
- The strategy provider earned USD 200 in profits, so strategy equity became USD 1200.
- Then the strategy provider incurred a USD 300 loss, so strategy equity became USD 900. This is the beginning of a drawdown as the equity before the drawdown was USD 1200.
- Next, the strategy provider made a loss of USD 500, so strategy equity became USD 400; the drawdown continued.
The strategy provider then makes USD 900 profit. So the 1st drawdown ended with equity at the end of the drawdown at USD 400 (strategy had growth after this figure).
1st drawdown is USD 1200 - USD 400 = USD 900
- Then the strategy provider made another USD 200 loss, so strategy equity became USD 1100 marking the beginning of another drawdown movement since equity was previously USD 1300.
- Next, the strategy provider makes a loss of USD 300, so strategy equity becomes USD 800; the drawdown continues.
The strategy provider then makes USD 600 profit, raising their equity to USD 1 400. This ends the 2nd drawdown when equity was at USD 800.
2nd drawdown is USD 1300 - USD 800 = USD 500
The 1st drawdown was USD 900, that is bigger than the 2nd drawdown of USD 500, so it is considered the maximum drawdown; the largest consecutive loss within a designated time period.
Please note: Maximum drawdown can amount to more than the initial balance if the profits climb high enough first before losses total more than the starting balance.