What Is Return Over Maximum Drawdown (RoMaD)?
Return over maximum drawdown (RoMaD) is a risk-adjusted return metric used as an alternative to the Sharpe Ratio or Sortino Ratio. Return over maximum drawdown is used mainly when analyzing hedge funds. It can be expressed as:
Introduction To Hedge Funds
Understanding RoMaD
Return over maximum drawdown is a nuanced way of looking at a hedge-fund performance or portfolio performance in general. Drawdown is the difference between a portfolio's point of maximum return (the "high-water" mark)and any subsequent low point of performance. Maximum drawdown, also called Max DD or MDD, is the largest difference between a high pointand a low point.
Maximum drawdown is becoming the preferred way of expressing the risk of a hedge-fund portfolio for investors who believe that observed loss patterns over longer periods of time are the best proxy for actual exposure. This is because these same investors believe hedge-fund performance does not follow a normal distribution of returns.
Examples of RoMaD
Return over maximum drawdown is the average return in a given period for a portfolio, expressed as a proportion of the maximum drawdown level. It enables investors to ask the question,"Am I willing to accept an occasional drawdown of X% in order to generate an average return of Y%?"
For example, if the maximum achieved value for a portfolio to date was $1,000 and the subsequent minimum level was $800, the maximum drawdown is 20% [($1000 – $800) ÷ $1000]. That is a scary number for investors, particularly if they were to bail out at the bottom with their investment 20% lighter.
Of course, that is only half the story. Imagine the same portfolio had an annual return of 10%. In that case, you have an investment with a maximum drawdown of 20% and a return of 10% for a RoMAD of 0.5. Now an investor can use that benchmark to compare performance with other portfolios. A RoMaD of 0.5 would be considered the more attractive investment over one with a maximum drawdown of 40% and a return of 10% (RoMaD = 0.25).
On the surface, the returns of these two portfolios arethe same, but one is much riskier.
RoMaD in Context
In practice, investors want to see maximum drawdowns that are half the annual portfolio return or less. That means if the maximum drawdown is 10% over a given period, investors want a return of 20% (RoMaD = 2). So the larger a fund's drawdowns, the higher the expectation for returns.
As with any metric of evaluation, the performance expectations are tempered by the performance of other investments during the same period. So there are times of challenging market conditions where a RoMaD of 0.25 is actually stellar, all things considered.
FAQs
Return over maximum drawdown (RoMaD) is a risk-adjusted return metric used as an alternative to the Sharpe Ratio or Sortino Ratio. Return over maximum drawdown is used mainly when analyzing hedge funds. It can be expressed as: RoMaD = portfolio return ÷ maximum drawdown.
What is the maximum drawdown limit? ›
Maximum drawdown (MDD) measures the maximum fall in the value of the investment, as given by the difference between the value of the lowest trough and that of the highest peak before the trough.
How is MDD calculated? ›
MDD = (Trough Value — Peak Value) / Peak Value
There are different types of drawdown measures and maximum drawdown is the one that considers the greatest movement from a high position in a portfolio to a low spot in it before a new height is gained.
Is maximum drawdown downside risk? ›
A maximum drawdown (MDD) is the maximum observed loss from a peak to a trough of a portfolio, before a new peak is attained. Maximum drawdown is an indicator of downside risk over a specified time period.
What is a good max drawdown percentage? ›
However, it is always recommended for investors and traders that drawdown should be kept below the 20% level. By setting a 20% maximum drawdown level, investors can trade with peace of mind and always make meaningful decisions in the market that will, in the long run, protect their capital.
Is maximum drawdown positive or negative? ›
No, Maximum Drawdown cannot be positive. It represents the percentage decline from the peak value, which is always negative.
What is 5% drawdown? ›
As the account balance increases, the trailing maximum drawdown follows the trader up until they achieve a profit target of 5% in the account. Once a trader has achieved a 5% profit target, the trailing drawdown is removed and traders can draw back down to their initial starting balance before breaching the account.
How is maximum drawdown calculated in prop firms? ›
The drawdown measures as absolute drawdown and is 6% of the initial balance for all programs at all levels. No matter how much the trader profits in the account, the maximum loss (drawdown) allowance increases. The trader can always choose to keep profits in the account in order to increase the maximum drawdown amount.
What is the Romad ratio? ›
ROMAD, or Rate of My Average Drawdown, is a measure of downside risk. It is calculated by dividing the total return by the average drawdown. The drawdown is the percentage decline in an investment from its peak value.
What is criteria for MDD? ›
Major Depressive Episode:
- 5 or more depressive symptoms for ≥ 2 weeks. - Must have either depressed mood or loss of interest/pleasure. - Symptoms must cause significant distress or impairment. - No manic or hypomanic behavior.
Clinical depression, also known as major depressive disorder (MDD), is a mental health condition that causes a persistently low or depressed mood and a loss of interest in activities that once brought joy. Clinical depression can also affect how you sleep, your appetite and your ability to think clearly.
What is maximum drawdown in backtesting? ›
Maximum drawdown is the largest peak-to-trough decline in the value of your trading account, measured as a percentage. It's an essential risk metric that shows you the worst-case scenario for your trading strategy. Remember, knowledge is power, so understanding drawdowns is the first step in taming them.
What is the advantage of drawdown? ›
Advantages
- You will have control over your savings and how they are invested.
- You can manage your money with the aim of generating further growth or to beat the effects of inflation.
- You can make changes to the income you receive.
- You will be able to pass any remaining funds in your pension pot on to your next of kin.
Drawdown is a measurement of risk. The higher the drawdown is, the riskier your model is. We have to distinguish between maximum drawdown and average drawdown.
How do you calculate return on investment over time? ›
ROI is calculated by subtracting the initial cost of the investment from its final value, then dividing this new number by the cost of the investment, and finally, multiplying it by 100. ROI has a wide range of uses.
What percentage gains does a 50% drawdown require to return to break even? ›
To recover from a 50% loss, an investor needs a 100% gain. During the bear market of 2007-2009, the S&P 500® Index lost approximately 55%, which required an approximate gain of 123% to break even.
How do you calculate maximum return on investment? ›
ROI is expressed as a percentage and is calculated by dividing an investment's net profit (or loss) by its initial cost or outlay. ROI can be used to make apples-to-apples comparisons and rank investments in different projects or assets.
