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|Drawdown and Maximum Drawdown|
Maximum Drawdown is one way to measure the riskiness of a mechanical
This is the maximum loss (compounded, not annualized) that the manager ever incurred during any subperiod of the entire time period. Conceptually, the calculation looks at all subperiods of the time period in question and calculates the compound return of the manager over that period. The maximum drawdown is the minimum of zero and all these compound returns.
Compared with other risk statistics, Maximum Drawdown is particularly easy to interpret and apply to your own situation.
How do we measure Maximum Drawdown? Look at the chart below. It shows the historical results of two alternative investment strategies
Figure I charts the growth of a hypothetical $10,000 investment account over a six year period of time. For each strategy, the colored line plots the increase, or decrease, of the original $10,000 investment over time.
“Drawdown” simply measures any decreases in the colored line – or investment balance – from any "peak to valley".
“Maximum Drawdown” is simply the largest drawdown experienced by a strategy during the period of time under study.
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