![]() Therefore, long-term investors may take incorrect decisions if they fear the severity of short-term losses as reflected by drawdown. Since drawdown provides a relative measure rather than an absolute loss, it is indicative of a temporary decline in the investment value. Investors can also use the drawdown of various stocks to appropriately diversify their portfolios.įactors to consider while using drawdown in investment strategies.If the stock may carry higher risks, a higher drawdown ratio is preferable and vice versa. By calculating the drawdown on a stock, a trader/investor can know its risk-to-return ratio.Similarly, investors can know about the right time to enter the markets. This helps in the easy identification of exit opportunities at higher profits. Looking at historical drawdowns of investments, investors and traders can understand the pattern of likely troughs and peaks.Some of the ways that investors/traders can use drawdown to their advantage are: Investors willing to take on higher risk against higher returns can go for stocks with higher drawdown.ĭrawdown should also be considered from an investment timeline perspective since it tells investors how much time it may take to recover the original investment value with the given drawdown.A low drawdown value means lower risk and stable investment.So what does a drawdown indicate about investment risk? This way, one can minimize losses and aim for higher profitability of the investment. How drawdown can be used in risk assessment?īy analysing drawdown, traders and investors can enhance their strategy through a more accurate risk assessment of their investments. 15 lakhs and deduct the lowest value of the investment or Rs. ![]() If we look at this from the drawdown perspective, we need to consider the highest value of the investment, which was Rs. 15 lakhs.Īs per the investor’s calculations, the portfolio has still earned positive returns of 30%. This brings down the investor’s portfolio value to Rs. 5 lakhs on this investment within a year, the returns are about 50%.Īt such a time, the market undergoes correction or falls. Most stock market traders or investors keep churning their capital by entering or exiting a stock from time to time. Here is an example to better understand how drawdown can be used as a stock market investment strategy. You can use the below image to create something similar for pictorial representation of the concept: Expressed in percentage form, it is calculated as the difference between the stock’s highest and the lowest price, or peak and trough within a certain time frame. This concept tells us the extent to which a stock’s value may decline. However, it should not be mistaken to be the same as a loss incurred due to purchase price and sale price differential. What is a drawdown?ĭrawdown is a phase in the stock markets that has the highest potential for loss in the investment value.ĭrawdown is the difference between the market’s peak and a subsequent trough within a time range. Let’s understand the meaning of drawdown and how it can enhance our decision-making capability in the markets. One such terminology that new market entrants should know about is ‘Drawdown’. This allows a better understanding of market functionality and a stronger grip on equity investments. To gain such expertise, investors must know about various market terminologies and what they mean. Investors who know how to maintain their positions even during market downtimes are considered wise and often tend to survive the markets in the long run.
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