Maximum drawdown, or MDD, is the deepest observed fall from an earlier
peak to a later trough in a capital curve. If the curve rises from 100 to 120
and then falls to 90, that episode's drawdown is 90 / 120 − 1 = −25%.
How traders use the term
“The system had a 25% maximum drawdown” describes the worst episode found in the period analysed. The number should identify the time window, valuation frequency, treatment of costs, and whether it comes from balance or total equity.
Maximum drawdown is historical and path-dependent: it is not the greatest possible loss and does not forecast the next drawdown. See Maximum drawdown for the full formula, duration and recovery conventions, and Recovery factor for a related performance ratio.
Sources
- MetaQuotes, MetaTrader 5 Help — Testing Report — Defines maximal drawdown in test reports as the largest fall from a local high to the following low.
- Magdon-Ismail et al., On the Maximum Drawdown of a Brownian Motion — Studies maximum drawdown and its dependence on the horizon in the model examined.