Maximum drawdown (MDD) is a metric for the largest observed loss between equity peaks. Using the Bitcoin chart as an example, we have a peak at 20k followed by another at 65k. The MDD in this case would be -84%, if you bought at 20k and sold at 3.2k. In a simulation, MDD represents the worst case scenario.
Why does this matter when evaluating strategies?
Referencing the example above, Bitcoin repeatedly created new lows for an entire year. As an investor, would you have the confidence to continue holding during this time, watching your equity drop again and again? While not all strategies are going to have a -84% MDD, it's important to remember the possibility for reversals, and that prices don't go up forever.
To our strategy creators reading this, you may find value in our article on setting performance expectations.