Maximum Drawdown

#### Categories: Expert mode | Neoland-App Dashboard

Published: 21. May 2021
Written by: Marius Siegert

The Maximum Drawdown shows you the largest continuous loss since the start of your AI and looks for the largest movement from a high point to a low point before a new high is reached.

The formula for calculating the maximum drawdown is as follows:

$Maximum Drawdown=\frac{Tiefpunkt- letzter Höchststand}{letzter Höchststand}$

To calculate the maximum drawdown, the last peak of the value of your portfolio is subtracted from the trough and divided by the last peak. The low point of your portfolio's value is the lowest value your portfolio has reached after the last new high point. Accordingly, the high is the highest value to which your portfolio rises after a low (Magdon-Ismail & Atiya, 2004, p. 99).

Generally, a low maximum drawdown is preferred because it indicates that the largest historical loss from the investment was small. If an investment never lost a cent, the maximum drawdown would be zero. The maximum possible drawdown is 100%, which means that the investment is completely worthless. However, it should be noted that only the size of the largest loss is measured, without taking into account the frequency of large losses.

As an example, the MSCI World is considered in the period from 01.01.2020 - 31.12.2020.

Figure 1: MSCI World price development, data from Yahoo Finance, own presentation

The low in this case is 69€, the last high is 102€. This results in:

$Maximum Drawdown=\frac{69€-102€}{102€}=32.4\%$

The maximum drawdown is therefore the cumulative loss that would have occurred if you had invested at the time of a peak. So if you had decided to invest in the MSCI World at the beginning of March, your investment would have fallen by a maximum of 32.4%.

Compare the maximum drawdown of the MSCI World with the current maximum drawdown of your AI on the Neoland Dashboard to get a first impression and directly compare the risk of both investment options.

Sources

• Magdon-Ismail, Malik and Atiya, Amir F, Maximum Drawdown. Risk Magazine, Vol. 17, No. 10, pp. 99-102, October 2004, Available from SSRN: https://ssrn.com/abstract=874069

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