THE 5-YEAR-OLD VERSION
Imagine you fall into a hole. A 10 cm hole is easy to climb out of. A 60 cm hole needs a much longer ladder, and the climb back takes far more effort than the fall did. A drawdown is how deep the hole is, measured from the highest point you had reached.
How far below its high has the Nifty 50 been?
| Global financial crisis | Covid crash | |
|---|---|---|
| Peak (closing) | 8 Jan 2008: 6,288 | 14 Jan 2020: 12,362 |
| Low (closing) | 27 Oct 2008: 2,524 | 23 Mar 2020: 7,610 |
| Fall | -60% in 293 days | -38% in 69 days |
| Back to the old high | 9 Nov 2010 (2.8 years after the peak) | 9 Nov 2020 (10 months after the peak) |
The cruel arithmetic of recovery
A fall and the gain needed to undo it are not the same number. Lose half your money and you need to double what is left just to get back.
| If it falls by | It must then rise by |
|---|---|
| -10% | +11.1% |
| -20% | +25% |
| -30% | +42.9% |
| -40% | +66.7% |
| -50% | +100% |
| -60% | +150% |
Why this decides your behaviour
In October 2008, an investor looking at a -60% loss had every reason to feel the market was finished. Those who sold near the bottom turned a temporary loss into a permanent one, and missed +76% in 2009. Those who could not sleep at a 60% fall probably should never have held that much in shares in the first place.
A useful question to ask before you invest
Not "how much can I make?" but "what fall can I sit through without selling?" If a 40% drop on paper would make you panic, hold less in shares. That is the point of mixing in gold or debt and sizing positions sensibly. The replay lab lets you rehearse this without risking a rupee.