Recovering Losses

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Recovering Losses

By Joshua Habben, Research & Risk Analyst

An important aspect of trading is that recovering losses is harder than losing them. While this may be true in a few aspects, this article will just focus on the mathematics involved. In order to fully recover from a loss or drawdown, the percentage growth of the recovery is always higher than the percentage growth of the loss.

For example, if a trader starts with a $1,000 account and then loses $500, that is a 50% loss, and the account is then at $500. In order to recover the loss and bring the account back to $1,000, a growth of $500 is needed. This $500 of the $500 account balance is 100% growth. The 100% growth for recovery is 2 times that of the 50% loss.

The table below shows different loss or drawdown levels and their corresponding recovery growth, as well as the ratio between the two (i.e. the recovery divided by the loss).

Note that the recovery and recovery / loss ratio grow exponentially as the size of the loss increase. Therefore, the larger the loss, the harder it is to recover from it and this difficulty grows exponentially.

Taking on too much risk can lead to very large drawdown from which it is extremely difficult to recover. Imagine making 400% growth. That is an exciting feat for traders, but had it come after 80% drawdown, then that 400% growth merely led to breaking even. Large drawdown can turn what would normally be a great achievement into a lackluster event.

Joshua Habben

Research & Risk Analyst

Integrity FX, LLC

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