Maximum Drawdown
The largest peak-to-trough decline an account or strategy has ever experienced.
Also called: max dd · peak to trough
In plain language
Maximum drawdown is the worst single stretch in a track record. It answers the question that actually matters: what is the most pain this approach has ever delivered?
It is a far better description of risk than volatility, because it is the number that decides whether a trader abandons a strategy at the worst possible moment.
The historical maximum is a floor, not a ceiling. The worst drawdown a strategy has seen is simply the worst one so far.
Why it matters
Sizing decisions should be made against a drawdown larger than any you have experienced, because eventually you will experience one.
Common mistakes
- Treating a backtest’s maximum drawdown as a hard limit on future losses.
- Choosing a strategy on returns alone without asking what the ride looked like.
Keep exploring
These concepts are connected. Understanding one usually makes the next one easier.
The decline from an account’s peak value to its lowest point before a new peak.
The probability that a series of losses reduces an account below the point of recovery.
The set of rules that decides how much you can lose, before you think about what you can win.
The average amount you expect to win or lose per trade over a large sample.
The amount of an asset you buy or sell in a single trade.