Maximum Drawdown
Maximum Drawdown (MDD) is a measure of the largest percentage loss from peak to trough over a selected time period for a portfolio or asset. It is an important risk metric used to assess the downside risk of an investment. The larger the maximum drawdown, the greater the potential loss of the asset or portfolio.
Definition: Maximum Drawdown (MDD) is a measure of the maximum percentage loss from a peak to a trough in a portfolio or asset over a selected time period. It is an important risk indicator used to assess the downside risk of an investment. The larger the maximum drawdown, the greater the potential loss of the asset or portfolio.
Origin: The concept of maximum drawdown originated from risk management and portfolio theory. As financial markets developed, investors and fund managers gradually realized the importance of not only focusing on returns but also on potential risks and losses. In the mid-20th century, with the introduction of Modern Portfolio Theory (MPT), maximum drawdown became widely accepted and applied as a risk measure.
Categories and Characteristics: Maximum drawdown can be calculated over different time periods, such as daily, monthly, yearly, or over the entire investment cycle. Its characteristics include:
- Simple and Intuitive: Maximum drawdown is expressed as a percentage, making it easy to understand and compare.
- Risk Assessment: It helps investors understand the potential loss in the worst-case scenario.
- Time Dependency: The value of maximum drawdown varies with different time periods, so it needs to be analyzed in conjunction with the specific investment cycle.
Specific Cases:
- Case 1: Suppose an investment portfolio has a highest net value of 1 million yuan in a year and a lowest net value of 700,000 yuan. The maximum drawdown of this portfolio is (1,000,000 - 700,000) / 1,000,000 = 30%. This means that within this year, the investor could face a maximum loss of 30%.
- Case 2: A stock has a highest price of 50 yuan and a lowest price of 35 yuan in a month. The maximum drawdown of this stock is (50 - 35) / 50 = 30%. This indicates that within this month, the investor holding this stock could face a maximum loss of 30%.
Common Questions:
- Can maximum drawdown fully reflect investment risk? Maximum drawdown is an important risk indicator, but it cannot fully reflect all investment risks. Investors should also consider other indicators, such as volatility and Sharpe ratio, for a comprehensive assessment.
- How to reduce maximum drawdown? Investors can reduce maximum drawdown by diversifying investments, setting stop-loss points, and regularly adjusting their portfolios.
