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Drawdowns: the number that decides if you stay
Most people judge an investment by its return. Experienced investors look first at the drawdown, because it decides whether you will still be invested when the returns arrive.
What a drawdown is
A drawdown is the fall from a peak in your portfolio's value to the lowest point before a new peak. If your account grows to ₹10,00,000, slips to ₹8,20,000 and then recovers, the drawdown was ₹1,80,000, or 18%.
Two numbers matter:
- Depth: how far it fell (the maximum drawdown is the deepest fall on record).
- Duration: how long it took to get back to the old peak. A 15% fall that lasts two years can be harder to live with than a 25% fall that recovers in three months.
The recovery maths
Losses and gains are not symmetrical. After a fall you are earning on a smaller base, so you need a bigger percentage gain to get back to where you were.
| Fall from peak | Gain needed to recover | ₹10 lakh becomes |
|---|---|---|
| 10% | 11.1% | ₹9.0 lakh |
| 20% | 25.0% | ₹8.0 lakh |
| 30% | 42.9% | ₹7.0 lakh |
| 40% | 66.7% | ₹6.0 lakh |
| 50% | 100.0% | ₹5.0 lakh |
The formula is simple: gain needed = fall ÷ (1 − fall). This is why controlling the size of losses matters more than chasing the size of wins.
Why drawdowns make people quit
Every strategy, however good, has losing stretches. The danger is behavioural: investors tend to abandon a strategy near the bottom of a drawdown, lock in the loss, and miss the recovery. The strategy's record looks fine; the investor's record does not.
The fix is to decide before you start how large a fall you can tolerate, and to size accordingly.
Sizing so you can stay
A practical approach:
- Pick your limit. Say you could sit through a 10% fall in your total savings without panicking.
- Assume the future is worse than the past. Live drawdowns often exceed the backtest's worst. A common planning rule is to expect 1.5 to 2 times the historical maximum.
- Scale down. If a strategy's historical worst is 15% at full size, plan for up to 30%. To keep that within your 10% limit, put roughly a third of the amount you first intended into it.
- Add hard limits. A maximum loss per trade and a daily loss limit stop a bad day from becoming a bad month.
Spreading money across strategies that do not lose at the same time also reduces drawdowns, often more than any single rule change.
Questions to ask about any strategy's drawdowns
- What was the maximum drawdown, and in which period did it happen?
- How long did the longest recovery take?
- Was the drawdown measured on closing values only, or including intraday swings?
- What risk limits stop losses from compounding?
Quick answers
What is a maximum drawdown?
Maximum drawdown is the largest fall from a peak to a trough in a portfolio's value over a period, usually shown as a percentage. It measures the worst loss an investor would have experienced before a new high.
How much gain is needed to recover from a 50% loss?
A 100% gain. After a 50% fall, ₹10 lakh becomes ₹5 lakh, and ₹5 lakh has to double to get back to ₹10 lakh. The general formula is gain needed = loss ÷ (1 − loss).
How should I size a strategy based on its drawdown?
Decide the largest fall in your total money you could tolerate, assume live drawdowns may be 1.5 to 2 times the historical worst, and scale the amount you allocate so that this larger figure stays within your limit.
Education only. This article explains general concepts. It is not research, a recommendation or investment advice, and it does not refer to any security. Amulya Holdings is not yet registered with SEBI. Investments in the securities market are subject to market risks.
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