What Is the Calmar Ratio?

The Calmar ratio is a measure of risk-adjusted performance that compares the average annual compounded rate of return (CAGR) to the maximum drawdown of an investment or trading strategy. It was created by Terry W. Young in 1991 and was originally called the Drawdown Ratio.

The ratio is particularly useful for evaluating trading bots and hedge funds because it directly addresses the relationship between returns and the worst-case loss scenario.

Formula and Calculation

The Calmar ratio is calculated as follows:

$$\text{Calmar Ratio} = \frac{\text{CAGR}}{\text{Maximum Drawdown}}$$

Where:

• CAGR = Compound Annual Growth Rate
• Maximum Drawdown = The largest peak-to-trough decline (expressed as a positive number)

For example, if a strategy has a CAGR of 20% and experienced a maximum drawdown of 10%, the Calmar ratio would be 2.0.

What the Calmar Ratio Can Tell You

The Calmar ratio helps investors understand how much return they're getting for the maximum downside risk they're exposed to. A higher ratio indicates better risk-adjusted performance.

Interpreting the Calmar Ratio

A Calmar ratio of 3.0 or higher is generally considered good, indicating that the average annual return is at least three times the maximum drawdown.

Negative Calmar Ratio

A negative Calmar ratio occurs when the CAGR is negative, meaning the investment has lost money on average. This indicates poor performance regardless of the drawdown.

Why the Calmar Ratio Matters for Trading Bots

The Calmar ratio is especially relevant for evaluating algorithmic trading strategies because:

1. Drawdown is intuitive: Maximum drawdown represents the worst loss an investor would have experienced
2. Recovery matters: Large drawdowns require even larger gains to recover
3. Sustainability: A low Calmar ratio may indicate unsustainable risk-taking

The Drawdown Recovery Problem

This asymmetry is why the Calmar ratio is so valuable—it penalizes strategies that take on excessive drawdown risk.

Calmar Ratio vs. Other Risk Metrics

The Calmar ratio is unique in using maximum drawdown, which represents actual historical worst-case performance rather than a statistical measure of volatility.

Time Period Considerations

The standard Calmar ratio uses a 36-month (3-year) rolling period for both CAGR and maximum drawdown calculations. This provides a balance between:

• Stability: Enough data to be statistically meaningful
• Relevance: Recent enough to reflect current strategy behavior

However, different time periods can be used depending on the analysis context.

Limitations of the Calmar Ratio

1. Historical dependence: Maximum drawdown is a single historical event that may not repeat
2. Time sensitivity: Newer strategies may not have experienced their true maximum drawdown
3. Doesn't capture frequency: A strategy with one large drawdown vs. many small ones may have the same ratio
4. No forward guarantee: Past drawdowns don't predict future ones

Example

Consider two trading bots over a 3-year period:

Bot A:

• CAGR: 25%
• Maximum Drawdown: 20%
• Calmar Ratio = $\frac{25\%}{20\%} = 1.25$

Bot B:

• CAGR: 15%
• Maximum Drawdown: 5%
• Calmar Ratio = $\frac{15\%}{5\%} = 3.0$

Even though Bot A has higher absolute returns, Bot B has a much better Calmar ratio, indicating superior risk-adjusted performance. An investor in Bot B would have experienced much smaller losses during the worst period.

FAQs

What is a good Calmar ratio?

A Calmar ratio above 3.0 is generally considered good for most investment strategies. For trading bots and hedge funds, a ratio between 2.0 and 5.0 is typically acceptable, with higher being better.

How often should I recalculate the Calmar ratio?

The Calmar ratio should be recalculated regularly, typically monthly or quarterly, using rolling 36-month data. This helps track whether a strategy's risk-adjusted performance is improving or deteriorating.

Can the Calmar ratio be negative?

Yes, a negative Calmar ratio indicates that the strategy has a negative CAGR, meaning it has lost money on average. This is generally a red flag for any investment strategy.

Why is maximum drawdown used instead of average drawdown?

Maximum drawdown represents the worst-case scenario that an investor actually experienced. Using the maximum rather than average gives a more conservative and realistic picture of the risk involved.

Related Topics

• Maximum Drawdown
• CAGR
• Sharpe Ratio
• Sortino Ratio