The mean depth of all declines below prior peaks, which describes the routine experience better than the single worst one does.
max-drawdown is one observation, and a badly estimated one - it depends entirely on whether the sample happened to contain the bad episode. Average drawdown uses every decline and is therefore far more stable across samples.
Read the two together. A strategy with a 6% average drawdown and a 30% maximum has a fat tail in its decline distribution: ordinary life is calm and the rare event is severe, which is the signature of negative return-skew. One with an 11% average and a 16% maximum is uniform and largely predictable.
Use the average for planning capital and the maximum for stress testing survival. Sizing off the average alone is how traders end up unable to withstand the event they were told about.
Original diagrams for the ideas on this page. Illustrative, not real market data.
Equity curve and drawdown. An account balance plotted month by month. The fall from the $16,000 peak to the $12,000 trough is a 25% drawdown, and the shaded area lasts until the balance climbs back to the old peak.The volatility smile. Options on the same stock and the same expiry are not priced off one volatility. Strikes near the money carry the lowest implied volatility, and it rises towards both ends — usually faster on the downside, which tilts the smile into a skew.
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