What Is Maximum Drawdown in a Backtest

Maximum drawdown in five lines

Maximum drawdown is the largest drop from any high on the equity curve to the lowest point after it, measured over the whole run. It is measured in pips, in money, or as a percent of the account at the high, and the percent is the one that hurts. It is not the worst trade; it is the worst run, which can be many small trades in a row. It matters because it is the hole a trader has to sit in without changing the rule, and because whatever the sheet says, the live one will be deeper. The example rule's curve peaked at 270.5 pips at trade 51 and fell to minus 29.0 at trade 106: a drawdown of 299.5 pips, where a pip is the fourth decimal place of the price, and 55 trades spent in the hole.

A high-water mark on a harbour wall

Picture a harbour wall with a high-water mark on it. The wall remembers the highest tide ever reached, the peak of the curve; today's water sits some way below it, the trough; the gap between the mark and the water is the drawdown. It is measured from the mark, not from the pier the account started on, which is why a rule that is still above its starting balance can be in a large drawdown, and why the mark only ever moves up. When the tide passes the mark, a new mark is painted and the drawdown is zero until the water falls again.

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