Examples Market Risk
Example 1: DAX, April 2000 - April 2003
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An investor, who entered the DAX in April 2000 would have lost 70% during a 3-year period until April 2003.
This loss would have been recovered until 2007 just to drop another 50% during the two years afterwards. |
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Example 2: Lindt & Spruengli, October 2007 - April 2009
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A common way to pick stocks is to look for supposed secure stocks. One such stock is the one from Swiss chocolate producer Lindt&Spruengli. An investor has to be aware, that during periods of market distress presumed secure stocks will also suffer a lot, even if it might be less than the drawdown of a general market index.
The stock of Lindt&Spruengli illustrates this issue, since it lost 55% during the financial crisis. Holding a secure stock will not protect an investor from high losses during a market crash. |
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Example 3: DAX and Lindt & Spruengli, January 2012 - July 2014
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Being aware of the high risks one equity investor might face could lead someone to avoid investments in the stock market at all. Consequence will be that such an investor will also miss the opportunities an equity investment provides. An equity investor who entered the DAX or Lindt&Spruengli in Januray 2012 would have made a profit of +65% until July 2014, which equals an annual return of +22%. Such a performance would hardly been achieved with other asset classes.
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Impact of a capped Drawdown on Return
How would the annual return of an investment would be impacted by a drawdown controlling strategy which on the other side will miss some performance of the market recovery?
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Conclusion
A risk-reducing strategy, which caps drawdowns during a crash from 55% to 35% could even underperform the following market recovery of 200% by 50% and will still outperform a simple buy-and-hold strategy significantly.
A risk-reducing strategy, which caps drawdowns during a crash from 55% to 35% could even underperform the following market recovery of 200% by 50% and will still outperform a simple buy-and-hold strategy significantly.