Risk methodology
Backtesting Risk Analysis
Backtest risk analysis examines the size, duration, and pattern of losses—not only final return. Drawdown, volatility, downside deviation, exposure, and tail behavior describe different dimensions of risk.
Drawdown measures the path of loss
Maximum drawdown is the largest peak-to-trough decline. Drawdown duration and recovery time add context because two strategies can have the same depth but very different recovery paths.
Volatility is not the same as loss
Volatility measures dispersion in returns. Downside deviation focuses on adverse variation, while neither statistic fully captures gaps, liquidity constraints, or model failure.
Normalize return for risk
Sharpe, Sortino, and Calmar ratios use different denominators. Compare them only when return frequency, annualization, benchmark, and risk-free-rate assumptions are consistent.
Research checklist
- Maximum drawdown and duration
- Downside and total volatility
- Exposure and concentration
- Consistent annualization assumptions
Questions and answers
What is maximum drawdown?
Maximum drawdown is the greatest percentage decline from a portfolio peak to a subsequent trough before a new peak is reached.