What it means
A drawdown is the drop in the value of an investment from a peak to a later low. The maximum drawdown is the largest such drop over the period measured, and it shows the worst pain an investor would have felt if they bought at the top and held through the bottom.
A fund with a small maximum drawdown has been a smoother ride than one with a large drawdown. ROMAD compares the reward with that worst-case experience.
If a strategy earns an annual return of 18% and its largest fall was 12%, the ratio is 1.5. A higher number means more return per unit of the worst loss.
The ratio is a close relative of the Calmar ratio, which is usually defined as annualised return divided by maximum drawdown over three years. ROMAD is used more loosely, so the return period and the measurement window should be stated every time.
Unlike measures built on standard deviation, it focuses on a single real event instead of an average of ups and downs. This focus is both its strength and its weakness.
A big loss is what makes investors sell at the wrong time, so the measure captures a real concern. However, it depends on one episode, and a manager who has not yet met a market crisis can look better than they are.
ROMAD should be compared only across strategies measured over the same period and ideally across a full market cycle. It also says nothing about how long it took to recover from the loss.
Used with other metrics, it gives a fuller picture of whether the return was worth the risk. For a business investor, the practical message is that returns and losses are not symmetrical.
A fall of 50% needs a gain of 100% to recover, so strategies with deep drawdowns have to work much harder to get back to where they started.
In practice
Real-world examples.
Example
A trader compares two strategies. Strategy A earns 20% with a maximum drawdown of 10%, giving a ROMAD of 2.0, while Strategy B earns 25% with a drawdown of 25%, giving a ROMAD of 1.0, so she prefers A.
Example
A family office reviews three hedge funds. One has the highest return, but its maximum drawdown of 30% is more than the family can stomach, and ROMAD helps explain why it ranks below a smoother fund. The family agrees on a rule that no manager may be funded if its past worst fall exceeded 20%.
Example
A manager of an automated trading system backtests the rules over ten years. She finds that adding a stop-loss rule cut the maximum drawdown from 24% to 15% and raised ROMAD from 0.8 to 1.2 even though the return barely changed.
Formula
Calculation
ROMAD = Return over the period / Maximum drawdown
Maximum drawdown = (Peak value - Trough value) / Peak value
Suppose a portfolio rises to a peak of $120,000 and later falls to a low of $105,600, before ending the year higher. The maximum drawdown is ($120,000 - $105,600) / $120,000 = $14,400 / $120,000 = 0.12, or 12%. If the portfolio's return for the year was 18%, then ROMAD is 18% / 12% = 1.5.Case study
Seen in the real world.
Greystone Systematic is an illustrative, fictional trading firm that ran two strategies with similar annual returns of about 14%. The founders were inclined to give more capital to the one with the slightly higher return.
When the analyst calculated ROMAD, the picture changed. The first strategy had a maximum drawdown of 28%, giving a ROMAD of 0.5, while the second had a drawdown of 10%, giving a ROMAD of 1.4.
In this fictional case the firm allocated most new capital to the second strategy and clients stayed invested through a rough market. The illustrative lesson is that similar returns are not equal if one demanded much more suffering, and ROMAD makes that visible. The analyst also noted that the second strategy recovered from its worst fall in four months while the first took more than a year.
Watch out
Common mistakes.
- Comparing ROMAD values for strategies measured over different time periods.
- Assuming that a good ROMAD in a calm period will hold in a crisis.
- Ignoring how long the recovery from the maximum drawdown took.
Questions
People also ask.
How is ROMAD different from the Sharpe ratio?
The Sharpe ratio uses standard deviation, which measures overall variability, while ROMAD uses only the single worst fall.
What is a good ROMAD?
Values above 1 mean the return exceeded the worst loss, and higher is better, but you should compare similar strategies over the same period.
Is ROMAD the same as the Calmar ratio?
They are very close, but the Calmar ratio normally specifies annualised return over a three-year window, whereas ROMAD can be applied to any stated period.
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