How to Calculate Maximum Drawdown and Interpret Portfolio Risk
Summary
Maximum drawdown measures the largest percentage decline from a previous peak to a later trough over a chosen observation period. The document gives the formula and explains that the peak must come before the trough, then walks through a stock price sequence to identify the deepest peak-to-trough loss. Its example reports a maximum drawdown of about 38.46%, illustrating how the calculation is applied to observed prices.
The discussion frames drawdown as a way to assess historical downside exposure and compare it with an investor’s tolerance for losses. It suggests considering the measure alongside total return, volatility, and market conditions when evaluating a strategy. A limitation is that the metric describes the worst decline in the sampled period; by itself it does not establish future risk, explain the cause of losses, or capture the full investment profile. The article’s general claims that lower drawdown can signal greater stability should therefore be treated as historical observations, not guarantees.
Key ideas
- Maximum drawdown is the percentage fall from a prior peak to the lowest subsequent value.
- The example price sequence produces a maximum drawdown of about 38.46%.
- A larger historical drawdown indicates a more severe observed decline, but does not predict future losses.
- Drawdown should be considered alongside returns, volatility, and market conditions.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.