๐งฉ What is a Drawdown?
A drawdown describes the decline of a portfolio from its last peak to its trough. It measures how much a portfolio has fallen in the interim, regardless of its long-term performance.
๐ Drawdown = temporary loss from the peak
Drawdowns are normal, unavoidable, and a natural part of any long-term investment strategy.
๐ช๏ธ Why Drawdowns Are Unavoidable
Markets do not move in a straight line. They fluctuate โ sometimes violently. Drawdowns are caused by:
- Market stress
- Interest rate changes
- Geopolitical events
- Recessions
- Sector rotations
- Liquidity crunches
Even the best strategies in the world have drawdowns. The difference lies in how well they handle them.
๐ง Psychology: Why Investors Fail During Drawdowns
The biggest danger is not the market โ but the emotional reaction to it.
Typical mistakes:
- Panic selling at the bottom
- Changing strategy at the wrong moment
- Overweighting „safe“ assets after the crash
- Re-entering the market too late
- Loss aversion (losses hurt twice as much as gains feel good)
๐ Drawdowns are less a financial risk than a psychological risk.
๐ How Drawdowns Are Measured
Key metrics:
1๏ธโฃ Maximum Drawdown (MDD)
The largest decline ever recorded.
2๏ธโฃ Average Drawdown
Typical declines over many periods.
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