What is Drawdown?
A drawdown is the percentage decline from a portfolio’s peak value to its lowest point before recovering. It’s a critical concept because recovering losses takes much more effort than losing them.
Example of Drawdown Impact
If your portfolio drops 50%, you need a 100% gain to recover.
| Drawdown % | Recovery Needed to Break Even |
|---|---|
| 10% | 11% |
| 20% | 25% |
| 30% | 43% |
| 50% | 100% |
| 70% | 233% |
The Psychological Impact of Drawdowns
Many traders panic when facing drawdowns and make irrational decisions like exiting at the worst possible time. Understanding that drawdowns are a normal part of investing helps traders stay disciplined and avoid emotional mistakes.
How to Manage Drawdowns?
- Use Stop-Losses: Never let a trade turn into a disaster.
- Reduce Position Size: During volatile markets, trade smaller.
- Keep Cash Reserves: Avoid going all-in at once.
- Think Long-Term: Markets recover, but reckless traders don’t.
