Thread by @technovestor

Drawdown- The D Word

Trading and Investing is simple. In investing, buy “quality” stocks, hold them till ever. Even if you bought them at the peaks of market like 2007, 2017, you may have to wait 3-5 years before seeing you get back a return on your investment.
In trading,

where typically people leverage, you want to cut the losing trade and ride the winning trade.
Well, simply put these things look great in practice and sounds intellectually stimulating. Aah, once one reads this and understands this, one is ready to be the next millionaire on

dalal-street.

However, as one engages in the journey to “riches”, one realizes that actual riches v/s the idea of getting rich has one big chasm to cross- the valley called “Drawdown”.
What is Drawdown? Simply put, if you invested 100 Rupees in a stock, and unluckily it turned

out to be a bad point in terms of timing when you invested, you may see a downside on your investment and you go into a drawdown. Say stocks falls to 90, then you are in a 10% (100-90)/100*100 drawdown. You take all such unlucky points and find the maximum of these, which will

give you maximum drawdown. Like say 20%, 30% were also some other points, then 30% is the maximum drawdown for that investment.
Many pundits of investing world will say that – “Till a loss is not realized, it is not a loss and only on paper”.

This is probably how most people are fooled into believing that mark-to-market risk is not a risk
Practitioners in real world trading and finance will tell you otherwise. NIFTY has seen a maximum drawdown of over 60%, in the 2008 Global Financial Crisis (GFC), a year also

marked by the collapse of the 150 year old investment bank Lehman Brothers.

During the crash of 2020, known to us as the “Covid Crash”, NIFTY fell around 38%. The Bank Nifty fell 50% during this period (February and March 2020). Even as you read this, you may say, so what,

it has recovered, right ?

Well, data from investment /wealth managers will tell you most investors may liquidate their holdings during such crashes driven by the fear of their portfolios going to zero or near zero. That hypothesis almost always never materializes, but fear is

much stronger emotion than greed.

In trading systems world, a system goes through an up and down journey of making and losing money. Many investors who deploy these systems commit the classic mistake of switching from a system which has gone into drawdown, to a system which

has made returns. It is like standing at the ticket window in a queue, and you see the other window next to your window, and the queue there is shorter. You leave your current queue and go to the other queue, only to realize by the time you got there, that queue has gone longer

and your existing queue has become shorter. Those who eventually stuck to their own queue may get the ticket eventually faster, and others who switched may lag behind.

Similarly, when deploying a system, you may want to stick to the existing system and continue going down

that path. This is easier said than done, but data has proven that investors who stuck to the plan rather than flipping too often (or without a method or algorithm which is tested, to switch), those investors may land up poorer.

A rose without thorns is alas a mirage.