Maximum Drawdown (MDD)
Categories: Credit
The value of an investment or portfolio bounces around over time. Ups and downs...peaks and troughs. The total return for a period measures the percentage difference from the beginning of a period to the end. It’s like the straight-line distance from New York to L.A. But not all journies involve straight lines. Sometimes, you travel from NYC to L.A. via Miami.
Maximum drawdown takes the journey into account. Specifically, it measures the greatest peak-to-trough move (in percentage terms) of a time period.
You have a stock portfolio that starts the year valued at $100,000. By March, it’s worth $150,000. Then it hits a summer slump and falls to $75,000 by September 1. However, you experience a late-year rally, and it closes the year at $200,000.
What’s the MDD for the year?
Well, the biggest peak-to-trough move took the portfolio from $150,00 to $75,000 (the move to $200,000 doesn’t count, since there wasn’t a decline from there...you're looking for the biggest sustained downward move). So the equation goes: ($75,000 - $150,000)/$150,000...or an MDD of -$50%.