The Maximum Drawdown Duration is an extension of the Maximum Drawdown but this metric does not explain the drawdown in dollars or percentages, rather it explains the length of time the account was in the Max Drawdown. Expressed in days, weeks, months, or in some cases, years.
A Max Drawdown is measured from the time a retrenchment begins to when a new high is reached. 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 Max Drawdown Duration is the time it took from the beginning of the retrenchment to the new high.
For example, the SPY started a retracement in Oct 2007 and did not reach a new high until April 2012. The SPY’s Max 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. Savings you may need to take care of relatively common expenses such as purchasing a car, meeting unexpected expenses or paying a child’s college tuition. Money unavailable for income needs to be drawn from the principle. And this 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 QiT uses the MDD Duration
At QiT we build our portfolios balanced – 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) QiT will always heed the Max Drawdown Duration.
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