If you have been investing or trading for any length of time, you have probably experienced that uncomfortable moment where your portfolio peaks, then quietly starts slipping backwards.
That is a drawdown. And it feels worse than it should, because most investors do not expect it, even though it is completely normal.
The truth is simple. Drawdowns are not a sign that something is broken. They are a natural part of how markets move. But how you respond to them determines whether you grow your wealth or sabotage it.
In this article, you will learn what a drawdown actually is, why it happens, and how SWS’s rules-based system is designed to handle it without emotional decision-making.
What Is a Trading Drawdown?
A trading drawdown is the drop from your portfolio’s highest value to a lower value. It measures how far your account has fallen from its most recent peak before it recovers again.
In simple terms
- Portfolio goes up.
- It hits a peak.
- Then it declines temporarily.
- That decline is the drawdown.
The formula is: Drawdown (%) = (Peak Portfolio Value – Trough Portfolio Value) / Peak Portfolio Value x 100.
For example, if your portfolio peaks at $100,000 and then falls to $80,000, your drawdown is ($100,000 – $80,000) / $100,000 x 100 = 20%.
A key concept is maximum drawdown, the largest decline experienced over a given period. This is one of the most important measures of risk because it tells you how painful the journey can get, not just what the final return looks like.
KEY IDEA
Drawdowns are not rare. Even strong portfolios spend a large portion of their time below previous highs.
Why Drawdowns Are Normal in Trading
Markets do not move in straight lines. They move in cycles of expansion, hesitation, and contraction. That means drawdowns are structurally built into investing.
Why they happen
- Market cycles shift constantly: what works in one phase may underperform in another.
- No system works all the time: every strategy has losing periods.
- Volatility creates temporary declines: price movement is never smooth.
- Returns are uneven: gains often come in bursts, not steadily.
ASIC’s MoneySmart notes that market volatility and temporary portfolio declines are a normal feature of long-term investing. The ASX also reports that Australian shares have delivered strong long-term returns, but those returns have always come with periods of decline.
This is why understanding discipline is more important than predicting outcomes. Emotional reactions do not just affect one trade. They disrupt the entire decision-making process.
Why Most Investors Struggle During Drawdowns
The drawdown itself is not the real problem. The reaction is.
Common emotional reactions
- Market cycles shift constantly: what works in one phase may underperform in another.
- No system works all the time: every strategy has losing periods.
- Volatility creates temporary declines: price movement is never smooth.
- Returns are uneven: gains often come in bursts, not steadily.
None of these is a system-based decision. They are emotional responses under pressure. This is where performance starts to break down, because consistency disappears before capital does.
How SWS Handles Drawdowns
SWS is built on one core principle: you do not manage markets. You manage behaviour inside a system.
What the SPA3 system defines before a drawdown ever starts
- When you enter a trade.
- When you exit a trade.
- How much risk to take per position.
- How exposure adjusts during periods of heightened volatility.
When the market turns against you, you do not have to decide what to do, react emotionally, or improvise. You follow predefined rules. This is the difference between discretionary trading and system-based investing.
Gary Stone spent more than 8,000 hours developing and refining the SPA3 system over 27+ years. The result is a rules-based approach with no room for improvisation, and no need for it.
You do not manage markets. You manage behaviour inside a system.
What SPA3's Track Record Shows During Real Market Downturns
One of the most important things you can know about any investing system is how it behaved when markets fell. Not in theory. In practice.
The SPA3 Investor portfolio has been operating as an open-book, audited real-money portfolio since January 2016. Every trade is recorded. Every drawdown period is on the record.
During the COVID market crash of February-March 2020, the SPA3 system followed its rules exactly as designed:
- Predefined exit signals reduced exposure before the worst of the decline.
- Position sizing rules limited the damage to each individual holding.
- Re-entry signals guided the portfolio back into the market as conditions recovered.
Data to confirm before publication
[INSERT: SPA3 Investor maximum drawdown during the February-March 2020 period – confirm from audited portfolio records]
[INSERT: ASX 200 maximum drawdown during the same period for comparison]
Since inception in January 2016, the SPA3 Investor portfolio has delivered 12%+ annualized returns, a track record built entirely on the same rules-based approach that managed those drawdown periods.
The Psychology Behind Staying Consistent
Most trading problems are not technical. They are behavioural.
What usually breaks down during a drawdown is not knowledge. It is discipline, patience, and rule adherence. Over time, consistency becomes more important than intelligence.
The investors who come out of drawdown periods in the strongest position are not the ones who predicted the bottom. They are the ones who never stopped following the rules.
Why Drawdowns Feel Worse Than They Are
Drawdowns feel amplified because of perception. The discomfort usually comes from uncertainty about recovery, lack of rules, and emotional attachment to results.
The fix is not a prediction. It is structure. When rules are clear, emotional interpretation drops significantly because the system already told you what to do before any of this happened.
Final Thoughts
Drawdowns are not rare events. They are a normal part of every trading and investing system.
The real question is not whether you will experience them. It is how you respond when you do.
SWS is built around that principle. The SPA3 Investor portfolio uses a fully rules-based, glass-box approach that has navigated multiple market downturns with documented, audited results since January 2016. No guesswork. No gut feel. Just a defined process you can follow in 15 minutes a week.
Frequently Asked Questions
What is a maximum drawdown in trading?
A maximum drawdown is the largest drop from a portfolio’s peak value to its lowest point before recovery. If your portfolio grows to $100,000 and falls to $80,000, that is a 20% drawdown. It matters because it shows the real risk of a system, not just its returns.
Why do drawdowns happen even in profitable systems?
Drawdowns happen because no system performs well in all market conditions. Markets shift between trends, volatility, and sideways movement, and a strategy will naturally underperform in some environments.
How long do trading drawdowns usually last?
Yes. Drawdowns are a standard part of all investing and trading systems. Most portfolios spend a significant amount of time below their previous highs. The key is not avoiding drawdowns, but having a system designed to operate through them without emotional decision-making.
Are drawdowns normal in investing?
Yes. Drawdowns are a standard part of all investing and trading systems. Most portfolios spend a significant amount of time below their previous highs. The key is not avoiding drawdowns, but having a system designed to operate through them without emotional decision-making.
How does a rules-based system help during drawdowns?
A rules-based system removes guesswork when emotions are highest. Instead of reacting to losses, you follow predefined rules for entries, exits, and position sizing.
General information only
This article is general in nature and does not constitute personal financial advice. Past performance is not a guarantee of future results. The information provided is intended for educational purposes only. Please consult a licensed financial adviser before making any investment decisions. Share Wealth Systems Pty Ltd is not a financial planning firm. For regulatory information, visit ASIC’s MoneySmart.
About Gary Stone
Gary Stone is the founder of Share Wealth Systems and creator of the SPA3 trading methodology. With 30+ years of market experience and 8,000+ hours of R&D, Gary's work bridges mechanical system design and trading psychology. Share Wealth Systems holds Australian Financial Services Licence AFSL 250900 | ABN 46 446 661 406.