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Two strategies can finish with the same return after taking very different paths. Maximum drawdown (MDD) measures the largest observed decline from a running equity peak. It is not a ceiling on future losses.
A fall from 1.2 million to 900,000
Suppose a hypothetical account rises from 1 million to 1.2 million, then falls to 900,000. The decline is 300,000, or 25% of its peak. Returning to 1.2 million recovers that drawdown; exceeding it sets a new high.
Drawdown = (running peak − current equity) ÷ running peak. MDD is the largest drawdown in the observation period. Include declines still unrecovered at the end of the sample.
Why a 25% gain is not enough
A 25% gain on 900,000 leaves 1,125,000. Recovering to 1.2 million requires 33.3%, because the gain starts from a smaller base.
| Drawdown | Gain needed to recover |
|---|---|
| 10% | 11.1% |
| 20% | 25.0% |
| 25% | 33.3% |
| 30% | 42.9% |
| 50% | 100.0% |
Required gain = 1 ÷ (1 − drawdown) − 1. Enter drawdown as a positive decimal. This calculation assumes the same account without deposits or withdrawals.
Make the comparison consistent
Match the period, starting capital, position sizing, costs, and valuation frequency. Mark-to-market equity includes open-position gains and losses; a closed-trade balance does not. Daily observations can miss a deeper intraday decline.
Separate cash flows from investment performance. A deposit restoring the balance is not a strategy recovering its losses.
Read the path as well as the percentage
Report recovery time, time below the peak, and losing streaks alongside MDD. Positive average returns do not make every drawdown tolerable. A historical maximum alone is an insufficient basis for choosing exposure.
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Research methods and reporting standards
For education and research. Numerical examples are teaching assumptions unless explicitly identified otherwise. Historical results do not guarantee future performance.