Every backtest shows a smooth headline return until you scroll to the equity chart and see the deepest dip. Max drawdown captures that worst loss from a prior high - the number that tells you how painful the path was, not just where you ended.
Definition
Maximum drawdown is the largest percentage (or dollar) decline from a peak in portfolio value to a subsequent trough before a new peak is reached.
If your strategy grew from $100k to $140k, then fell to $105k before recovering, the drawdown from the $140k peak is:
(140,000 - 105,000) / 140,000 ≈ 25%
That 25% is a candidate for max drawdown if no other peak-to-trough move was larger.
Why traders care
- Psychological tolerance: Can you stick with the strategy through a 30% dip?
- Leverage and margin: Deep drawdowns can force de-risking or liquidations in live accounts.
- Comparing strategies: Two strategies with similar returns can have very different drawdown profiles.
Sharpe ratio rewards smooth returns; max drawdown punishes the worst chapter of the story. Use both.
Max drawdown vs daily loss
A bad single day is not necessarily your max drawdown. Drawdown is measured on the cumulative equity curve and can span weeks or months of underwater periods.
Calmar ratio connection
Calmar (annualized return divided by max drawdown) is a compact risk-adjusted metric that weights return against your worst historical slump. It is sensitive to one bad regime - always check how long recovery took.
Limits
- Backtest drawdown is not a guarantee of future pain; regimes change.
- Short samples may miss rare crises; stress-test with longer history and Monte Carlo where available.
- Does not capture tail risk shape beyond the single worst episode.
On Quantly, max drawdown appears on backtests and tear sheets alongside Sharpe and volatility. Use it to ask: "Could I have stayed invested through this?"
Explore the demo or join the waitlist to run your own tests.
