Maximum Drawdown
The largest peak-to-trough decline of equity over a given window.
Definition
Maximum Drawdown (MDD) is the worst observed loss from a previous high before a new high is made. It is the single most psychologically relevant risk metric because it represents the maximum unrealised pain an investor would have experienced. Recovery time (time-under-water) is just as important: a 50% loss requires a 100% gain to break even. MDD is reported as a negative percentage and is the denominator of the Calmar Ratio.
Formula
MDD = min_t ( Equity_t / max_{s<=t}(Equity_s) - 1 )
Drawdown_t = Equity_t / Running_Peak_t - 1
MDD = min over time of Drawdown_tWorked example
A portfolio rises to $150,000 from a starting $100,000, then falls to $90,000, then recovers to $200,000, then falls to $130,000. The drawdowns are (90 - 150)/150 = -40% and (130 - 200)/200 = -35%. Maximum drawdown is -40%, even though the lower equity value occurred at $90,000.
How ARIA Analyst uses it
ARIA tracks live drawdown on every paper and live portfolio and triggers protective alerts in the Risk Agent when current drawdown exceeds a user-defined threshold.
Related terms
Calmar Ratio
Annualised return divided by maximum drawdown, favouring strategies with shallow losses.
Value at Risk (VaR)
The maximum loss expected over a given horizon at a given confidence level.
Conditional VaR (Expected Shortfall)
The average loss in the worst (1 - alpha)% of cases — a coherent tail-risk measure.
Volatility (σ)
Standard deviation of returns — the most common dispersion-based risk measure.
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