What is Maximum Drawdown Duration?

What is Maximum Drawdown Duration?

 

The Maximum Drawdown Duration is an extension of the Maximum Drawdown but describes the drawdown from the perspective of time rather than dollars or percentages. It is expressed in days, weeks, months, or in some cases, years.

To recap, a Maximum Drawdown is measured from the time a retrenchment begins to when a new high is reached and it’s the maximum an account lost during that retrenchment. This method is used because a valley can’t be measured until a new high occurs. Once the new high is reached, the percentage change from the old high to the bottom of the largest trough is recorded. So the Maximum Drawdown Duration is the time it took from the beginning of the retrenchment to the new high.

At AlgoTrader we build our portfolios balanced


 

 

For example, in the chart above of the SPY, the ETF started a retracement in Oct 2007 and did not reach a new high until April 2012. In other words, the SPY Maximum Drawdown Duration, if using a backtest timeframe from January 1, 2007 to today, would be 72 months or 4 ½ years. It’s very important to understand the Maximum Drawdown Duration because during any financial disaster such as this, it’s very difficult to withdraw even a modest 5% per year from savings to take care of relatively common expenses such as purchasing a car, meeting unexpected expenses or paying a child’s college tuition. If this money is needed for income then the principle must be used which subsequently leaves less money to build upon once the account starts to make new highs again. This means that everyone must realistically understand the how long they can handle a drawdown.

How AlgoTrader uses the MDD Duration

– if one algorithm is in a drawdown then another one in the same portfolio is making new highs. While this is not always 100% possible (there is no guarantee for the future) AlgoTrader will always heed the Maximum Drawdown Duration.

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