What is Maximum Drawdown? What can we learn from a trading strategy with a Maximum Drawdown of 20%?

Maximum Drawdown is the maximum percentage decline from a peak to a trough in a specific period for a portfolio or asset, which is an important indicator for measuring investment risk.

By analyzing Maximum Drawdown, investors can evaluate the extent of losses a trading strategy has experienced in the worst-case scenario. Specifically, the data of Maximum Drawdown can help investors assess the maximum risk and potential loss that a trading strategy has faced in history. Investors can evaluate the risk tolerance of a strategy based on this data and consider the strategy's performance comprehensively by combining other indicators such as Sharpe Ratio and Profit Factor.

If a quantified automated trading strategy shows a Maximum Drawdown of 20% in backtesting, it means that the strategy has experienced a maximum decline of 20% in asset value during the backtesting period. That is, if the asset value of the strategy reaches $100,000 at a certain point in time, it may drop to $80,000 at worst.

Generally, the smaller the Maximum Drawdown, the smaller the investment risk associated with the trading strategy. However, it is important to note that past performance does not guarantee future performance. Investors should consider other factors comprehensively and take appropriate risk management measures when making investment decisions.

Here are some commonly used indicators:

Sharpe Ratio: Measures the risk-adjusted return of a trading strategy, indicating the excess returns obtained for each unit of risk.

Profit Factor: Measures the ratio of gross profit to gross loss, indicating the profit-generating ability of a trading strategy.

Win Rate: Measures the percentage of profitable trades compared to total trades executed by a trading strategy.

Return: Measures the rate of return generated by a trading strategy.

Considering these indicators comprehensively can provide a more complete evaluation of the strengths and weaknesses of a trading strategy, helping investors make more accurate decisions and manage risks. However, it should be noted that these indicators have their own limitations and should be analyzed comprehensively with specific market, asset, and time period factors.