Maximum Drawdown

Maximum Drawdown (MDD) is the single largest peak-to-trough percentage decline in the equity curve of a portfolio over a chosen window. It does not depend on a probability distribution, only on the realised path. Two portfolios with identical annual return and volatility can have very different drawdowns — and drawdown is what most investors actually experience as risk.

Formula

Let V_t be the cumulative portfolio value at time t. Define the running maximum:

M_t = max( V_0, V_1, …, V_t )
DD_t = ( V_t − M_t ) / M_t
MDD = min_t ( DD_t )

MDD is a negative number expressed as a percentage. An MDD of −34% means the portfolio lost 34% from a previous high before recovering.

Why MDD matters

• ·Behavioural: most investors capitulate at the MDD point, not at the volatility point. A 35% drawdown takes a 54% gain to recover from.
• ·Capital adequacy: leveraged portfolios that hit a margin call at the MDD point face forced deleveraging.
• ·Strategy ranking: two strategies with the same Sharpe but different MDDs are not equivalent — the lower-MDD strategy is the one a real human can hold through.

Recovery time

A complementary metric is the time-to-recovery: how long it takes for the equity curve to make a new high after the trough. The 2008 GFC MDD was −55% for the S&P 500; recovery to the pre-crisis high took 65 months. The 2022 MDD was −25%; recovery took 16 months. Same metric, very different lived experience.

How MEDGE Capital uses MDD

MDD is computed peak-to-trough on the total return series (not calendar-based) for every portfolio backtest. The Crisis Library presets — 2008 GFC, 2020 COVID, 2022 Bear, 2018 Q4 — surface the MDD in each regime with one click, plus the Calmar ratio (CAGR / |MDD|) which is the canonical "return per unit of drawdown" measure.