Maximum drawdown

The largest fall from a peak to a later trough over a period: the worst loss an investor who bought at the top would have lived through. It depends on the path the sample happened to take.

Where you will meet it

Maximum drawdown appears in 6 learning outcomes on the CFA syllabus. A few of them:

• Set out risk measures suited to return distributions that are not normal
  CFA Level I · Alternative Investments

  “Downside deviation, the Sortino ratio, maximum drawdown and value at risk each address part of it by focusing on the loss side, though none is a complete substitute for understanding the strategy's payoff structure.”

• Interpret the metrics and charts that a strategy backtest reports
  CFA Level II · Portfolio Construction

  “A backtest report usually shows cumulative return charts, average returns, volatility, the Sharpe ratio, maximum drawdown, turnover, and the information coefficient or hit rate of the signal.”

• Assess what adding a hedge fund strategy to a traditional portfolio does to that portfolio
  CFA Level II · Alternative Investments

  “Maximum drawdown, skewness and stress-period behaviour matter too: merger arbitrage looks diversifying on average but tends to fall with equities in crises, whereas managed futures and global macro have tended to help most then.”

• Compute and interpret maximum drawdown, drawdown duration, upside and downside capture ratios, the appraisal ratio and the Sortino ratio
  CFA Level III · Performance Measurement

  “Maximum drawdown is the largest peak-to-trough fall in cumulative value; drawdown duration is the time from the peak through the trough until the prior peak is regained.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with M · Glossary