Max Drawdown

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Definition

Max drawdown is an indicator of the risk of a portfolio chosen based on a certain strategy. It measures the largest single drop from peak to bottom in the value of a portfolio (before a new peak is achieved).

For example if a portfolio starts being worth $100,000, increases in value to $150,000, decreases to $90,000, increases to $120,000, then decreases to $80,000, then increases to $200,000, the max drawdown is ($150,000-$80,000)/$150,000 = 46.67%

Note that the highest peak of $200,000 is not included in the calculation because the drawdown began at a peak of $150,000. Also note that the increase to $120,000 before the drop to $80,000 has no effect on the drawdown, because $120,000 was not a new peak.

Formula

Max Drawdown = (Peak value before largest drop-Lowest value before new high established)/(Peak value before largest drop)

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