Maximum Drawdown Excel Workout
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Maximum Drawdown (MDD)
June 13, 2025
What is Maximum Drawdown?
Maximum Drawdown (MDD) is a key metric in portfolio management that represents the maximum decline in the value of the investment over a specific period. It is expressed as a percentage and measures the largest peak-to-trough fall in the value of an investment before a new peak is achieved. It is commonly used to evaluate the risk of investment strategies by comparing the downside performance of different portfolios, where a lower reading indicates better capital preservation during periods of market stress. To get a more accurate perspective of the risk features of a portfolio, investors would typically examine the maximum drawdown over a full market cycle (as defined by the period between two highs – a bull to a bear market and then back to bull). In addition, the metric is also widely used alongside other performance indicators, for example, absolute and relative returns as well as risk measures such as volatility.
Key Learning Points
- Maximum drawdown is typically used as a measure of downside risk, in which large maximum drawdowns indicate that down movements could be volatile
- It helps investors to assess how much they could potentially lose from the highest point of their portfolio’s value to its lowest point
- Maximum drawdown could only be used to assess the potential volume of a loss over a specific period, but it does not consider the frequency of losses
Understanding Maximum Drawdown
Maximum drawdown is a relatively straightforward calculation that aims to provide a future indication of the maximum loss a portfolio can incur over a specific period. Being based on historical data, it measures the greatest movement from a high point to a low point, before a new peak is achieved. A low reading would typically signal lower volatility in the value of the investment (i.e. lower risk) and vice versa. However, there are also some limitations – the calculation does not take into account the frequency of large losses, but only the size of the largest decline in value. As it is a drawdown measure, it cannot help with other important aspects such as the time it took an investor to recover from the loss (or if a recovery took place at all).
Maximum drawdown is a closely monitored measure by investment firms such as asset managers or hedge funds as an indicator of downside risk. A lower MDD compared to a peer group average or a benchmark index, would signal the capital preservation qualities of a strategy/portfolio. In addition, it can also be used to monitor the downside risk for an individual asset, for example a specific stock of a company that a portfolio manager keeps an eye on. This allows investors to make relevant comparisons and support their decision-making in cases where other risk measures such as volatility or tracking error are identical for two or more assets.
Formula for Maximum Drawdown
The formula for maximum drawdown is as follows:
MDD = (P – L) / P
Where: 
MDD = Maximum Drawdown
P = Peak value before the largest drop
L = Lowest value before a new high is reached
Generally speaking, there are two primary approaches to consider the results:
- Absolute basis – used to identify strategies that minimize losses during periods of market falls. Examples include low-volatility strategies
- Relative basis – used to identify strategies that show consistent above-market performance, where an index represents market returns. For example, global strategies may be benchmarked against the MSCI All Country World Index (ACWI)
Let’s suppose that two portfolios have the same average outperformance (as measured by relative returns against the same benchmark), tracking error, and volatility. However, their maximum drawdowns compared to the index may be different.
| Month | Portfolio A
(% Relative Returns) |
Portfolio B
(% Relative Returns) |
| Jan | 2 | 2 |
| Feb | (-1) | 2 |
| Mar | 2 | 2 |
| Apr | (-1) | 2 |
| May | 2 | 2 |
| Jun | (-1) | 2 |
| Jul | 2 | (-1) |
| Aug | (-1) | (-1) |
| Sep | 2 | (-1) |
| Oct | (-1) | (-1) |
| Nov | 2 | (-1) |
| Dec | (-1) | (-1) |
While both portfolios have the same relative returns over the period, investors would typically prefer Portfolio A since it experiences a lower (and shorter) maximum drawdown.
Example of Maximum Drawdown
In the example below, we provide a real-world case that requires calculating the maximum drawdown of a fund.
Conclusion
To sum up, maximum drawdown is an important metric that quantifies the downside risk of a portfolio or an asset. It is popular across a broad group of investment professionals such as research analysts, portfolio managers, and risk professionals.
Based on past data, it offers an informed indication of the magnitude of potential losses and helps investors assess the resilience and capital preservation features of their strategies. It is also helpful when used in combination with other metrics such as relative or absolute returns. A strategy that delivered high returns over a specific period but achieved that with large drawdowns may be less attractive than a strategy with moderate returns and smaller drawdowns (especially for risk-averse investors).