Read the path with maximum drawdown
Measure a loss from a previous equity peak, not from the initial balance.
A loss relative to a peak
Consider wealth of 1.00, 1.20, 0.96 and 1.10. The final return is positive, but the fall from 1.20 to 0.96 is 20%. Maximum drawdown is the largest such decline in the observed path.
For each observation, track the greatest wealth seen so far. Calculate 1 - current_wealth / running_peak. The maximum of those values is maximum drawdown, expressed as a positive loss magnitude.
Include the initial wealth
A curve should start at wealth 1 before the first return. Otherwise an immediate loss can disappear from the drawdown calculation. Our lab includes that initial point.
A new high resets the reference peak; it does not erase an earlier drawdown. A flat curve has zero drawdown. With extreme leverage, wealth can become negative, requiring additional interpretation beyond this introductory model.
What the number leaves out
Maximum drawdown depends on the observation frequency and the sample period. Daily closes can miss intraday losses. A historical maximum is not an upper bound on a future decline. State the period and data frequency alongside the metric.
Inspect a curve, study costs and drawdowns, or write a risk explanation.