Maximum Drawdown (MDD) identifies the single largest loss from peak to trough across an entire measurement period. If a portfolio peaked at $100, then fell to $40, then recovered and peaked again at $120, then fell to $90 — the Maximum Drawdown is 60% (the $100 → $40 drop), even though the portfolio later recovered and reached new highs.
MDD is widely used to compare the risk profiles of different strategies. A strategy that produces the same long-run return as buy-and-hold but with a lower maximum drawdown is generally superior, because it imposes less behavioural stress and requires less recovery time. However, MDD is a historical figure — a strategy's past maximum drawdown does not cap its future one.
When evaluating a timing strategy, the pair that matters is maximum drawdown versus the timing cost paid to avoid it. If a strategy's exits reduce the MDD from 50% to 30% but also cause the investor to miss 15% of the subsequent recovery (through whipsaws and delayed re-entry), the net benefit is smaller than it appears.