What does the term “maximum drawdown” generally refer to?

The term "maximum drawdown" specifically refers to the highest peak-to-trough loss in a portfolio, representing the largest decline from a historical peak to a subsequent trough. This metric is critical for assessing the risk associated with investment strategies, as it quantifies the worst-case scenario regarding capital loss from an investment or trading strategy during a certain period.

Understanding maximum drawdown helps investors gauge the volatility and risk tolerance levels of their portfolios. It allows them to make informed decisions based on how much they can afford to lose before they decide to exit a particular investment or strategy. Other metrics, such as total profits or average returns, do not capture this aspect of risk and loss, which is why they are not suitable definitions for maximum drawdown.