QQ 102, 2 min read

Drawdown

After this lesson you can

Compute maximum drawdown from an equity series
Explain why depth and length both matter
Read a backtest drawdown as a lower bound

A drawdown is how far the account has fallen from its highest point so far.

drawdown now     = (peak equity so far - equity now) / peak equity so far
maximum drawdown = the largest drawdown over the whole history

An account that grows from 100 to 150, falls to 105, then rises to 200 had a maximum drawdown of 30%: from 150 down to 105.

Why it matters more than volatility to most people

Volatility is an average over the whole history. A drawdown is lived through day by day. A 30% drawdown is months or years of watching the account sit below a number it has already reached. Most strategies are abandoned in a drawdown, usually near the bottom.

Remember the recovery arithmetic from the first lesson: a 30% drawdown needs a 43% gain to get back.

Length as well as depth

How long the account stayed under water matters as much as how deep it went. A 15% drawdown that lasts three years is harder to live with than a 25% one that lasts three months.

What the backtest figure leaves out

The maximum drawdown in a backtest is the worst that happened in that one history. The future is a different draw. A longer history, or the same trades in a different order, would show a different worst case, and usually a deeper one. Treat the backtest figure as a floor for what to expect.

The terminal's Monte Carlo checks reshuffle the trades to show how much worse the drawdown could have been with the same trades in another order. See Validation, check by check.

Key points

Drawdown is the fall from the highest point so far
Most strategies are abandoned during a drawdown
The worst drawdown in one history understates the worst possible

Check your understanding

Equity goes 100, 140, 98, 160. What is the maximum drawdown?
Why is the maximum drawdown in a backtest best read as a floor?