Maximum Drawdown (MDD) is a critical risk metric that quantifies the largest peak-to-trough decline in a portfolio’s value. It answers the question: “What was the worst loss I would have experienced if I had invested at the worst possible time?”
How It’s Calculated
- Track the running peak (highest portfolio value seen so far)
- At each point, calculate the decline from the peak:
(Peak - Current) / Peak - The maximum of all these declines is the Max Drawdown
Why It Matters
- Risk Tolerance: A strategy with 40% CAGR but 60% max drawdown may be psychologically impossible to hold through
- Comparison: Two strategies with similar returns but different drawdowns have very different risk profiles
- Capital Requirements: Large drawdowns require proportionally larger recoveries (a 50% loss needs a 100% gain to break even)
Typical Benchmarks
| Asset | Typical Max Drawdown |
|---|---|
| Nifty 50 | 50–60% (2008 crisis) |
| Conservative strategy | 10–15% |
| Aggressive momentum | 25–40% |