We've discussed the definition of maximum drawdown, so it's high time we told you how it's actually computed. The maximum drawdown formula is quite simple:
MD = (LP - PV) / PV × 100%
where:
MD
– Maximum drawdown, in percent;LP
– Lowest value after peak value; andPV
– Peak value.
Let's evaluate the maximum drawdown of the S&P500 index ETF, the SPY, and compare it to the most famous cryptocurrency, Bitcoin. You can verify both results in our maximum drawdown calculator.
For the SPY, we have the biggest drawdown to be around March 2020, when the OMS declared the COVID-19 a pandemic disease. There we saw:
SPY peak value = 276.21
SPY lowest value after peak value = 222.83
Therefore, SPY maximum drawdown = -19.33%
On the other hand, Bitcoin experienced its maximum drawdown during December 2017 and December 2018. There we had:
BTC peak value = 19252.96
BTC lowest value after peak value = 3178.62
So, BTC maximum drawdown = -83.49%
Because the maximum drawdown of BTC is more significant (over four times), we can state that BTC involves much more risk than SPY. Consequently, asset allocation should be lower when building a portfolio for a more risk-averse investor.