# Maximum drawdown definition

Is it: 1. difference between Global maximum (HWM) and lowest value, or 2. largest DROP between an uptick and lowtick. Schweser has a diagram that seems to imply 2. above, but the CFAI readings seem to indicate 1. Anyone clarify? Thanks,

i believe its (1) - its related to the volatility measurement of hedge funds. You look at the stated Hedge Fund Return / Maximum Drawdown as a measure of volatility (HWM - Lowest Point for a given period). In the CFAI , its in the Alternative Investments.

Oh boy do I know that answer. It’s absolutely #1. Edit: With the addition that the lowpoint is after the maximum.

^agree with Joey. A drawdown is the difference between the High Water Mark (Highest NAV) and the subsequent drop to the lowest NAV after the HWM is reached. So, if My NAV was 100 and it dropped to 95 before coming back up to 100 it would be 5%. What’s also important is the time period over which this drawdown occured and how long it too them to recover from the drawdown.

what if the data points are 100, 80, 105, 100, 95, 90. Is the max draw down 100 - 80 ? or 105 - 90 ?

20 Edit: Note that 100 was a high H2O mark.

that makes more sense…thanks

Oh man, now I’m confused. I thought it was global HWM-Lowest subsequent value. Wouldn’t that be 105-90?

The first Drawdown woul be 100-80 = 20, the next drawdwon would be 105-90 = 15

It would be, but that’s not the def of max drawdown. If it was then oodles of hedge funds could claim their max drawdown was 0 right after they hit their Hi H2O mark.

^yes you are correct…what I stated were the Drawdown Periods, the MAX drawdown would still be 20. Sorry for the confusion.

One of the problems with the statistic is that it never gets better so if you are an existing fund, your worst drawdownmight have happened in 1987 (well…) when everything about everything was different than now.

okay, so it’s the largest drop between a HWM and the low pt following that HWM? hope that’s right because it makes sense to me now…

So, it’s not actually the difference between Global max and the subsequent min, but the largest drop between a local max and a subsequent local min.

yep.

The important thing with Drawdowns is to analyze when they happened with certain events that occurred. If you look at soem Quant L/S funds you’ll most likely see a nice Drawdown in July/August to about October of last year…

Also, I should say the Magnitude is important as well.