How Much You’ll Need To Recover After A Trading Drawdown

There are times when you’ll go through the inevitable drawdown (a drop in your portfolio value after one or a series of losses).

Not only does your portfolio drop in value but also, you’ll need to make up a certain percentage return to recover your portfolio back to what it was.

But what is that percentage return needed for recovery?

This is what I’m going to help tackle today.

The Drawdown versus the recovery percentage needed

It’s an unusual topic to tackle.

When you are down 5% of your portfolio, you’ll need 5.2% to get your portfolio back to what it was.

When you’re down 20% of your portfolio, you’ll need 25% to recover your portfolio back to scratch.

When you’re down 50% of your portfolio, you’ll need 100% of your portfolio to recover.

However, as you fall deeper into the drawdown, things start to become quite scary.

Here’s a formula you’ll need to calculate the percentage gain to make up for the percentage loss in your portfolio.

Required Gain = [1 ÷ (1 – Percentage loss)] – 1

Let’s start with an easy example.

Let’s say Alex is a new trader. He deposited an initial R100,000 into his trading account. After just three months of trading the markets with no strategy, plan and rules, he suffers a 50% drawdown.

This means he’s down R50,000 on his portfolio.

Let’s plug this amount into the Required Gain formula to see what Alex needs to achieve to get his portfolio back to what it was.

Required Gain = [1 ÷ (1 – Percentage loss)] – 1

                     = [1 ÷ (1 – 0.50)] – 1

                     = 1

This means Alex requires a 100% gain to restore his original portfolio value.

Easy enough…

I’m sure you could have calculated that without the formula. The problem lies when the drawdowns are bigger than 50%.

Let’s put this into perspective.

If Alex suffered a 70% drawdown on his portfolio, it’s quite staggering what he’ll need to recover.

Required Gain = [1 ÷ (1 – Percentage loss)] – 1

                     = [1 ÷ (1 – 0.70)] – 1

                     = 2.33

233% is what he needs to get his portfolio back in the green after a 70% drawdown.

It’s time to take your drawdowns more seriously

You can clearly understand why you’ll need to take your drawdowns a lot more seriously in the future.

In fact, with trading or with any business you should never be down more than 20% of your portfolio.

Keep reading these articles, because in the next few weeks I’ll be tackling what you should do to recover after a drawdown.

“Wisdom yields Wealth”

Timon Rossolimos
Analyst, BlackStone Futures

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