Drawdowns: “Active” versus “Passive”

December 13, 2016, was a historic day.

The Nasdaq 100 (QQQ) closed above $120 for the first time in almost 17 years!

That’s right… anyone who bought the Nasdaq in early 2000, just before the March 24 peak, has been suffering through a 17-year-long drawdown.

Can you imagine waiting that long just to get your money back? Never mind actually making a profit!

I know… I know… you’ve had “buy and hold” preached at you for all of your investing career. You’ve been told the “hold” part is psychologically difficult, but ultimately worth it in the end.

But is it really worth it?

Or, is there a better way through “active” investing?

We’ll answer that question today.

Before we do that, realize that drawdowns are a simple fact of life in investing. Sometimes they’re small and short. Sometimes they’re large and long.

You can work to minimize drawdowns (that’s risk management). But you can’t eliminate them.

So what does the typical drawdown – for both “buy and hold” and “active” strategies – look like?

Look at this chart from Ben Carlson’s blog, A Wealth of Common Sense.

He crunched the numbers and determined that the S&P 500 spends…

  • 13% of its time in a 5% to 10% drawdown,
  • 13% of its time in a 10% to 20% drawdown, and
  • 23% of its time in a drawdown greater than 20%

The S&P 500 has been in drawdown more than 70% of the time, since 1927!

And at least half the time, buy-and-hold portfolios were in a drawdown of 5% or more.

Since most investors panic-sell during drawdowns – particularly those bigger than 20% – it’s easy to see why the “hold” part of buy-and-hold is so difficult (psychologically) and damaging (economically).

This situation is not unique to the S&P 500. It’s the typical state of all equity markets, across all time periods: most of the time in drawdown; occasionally making new highs.

But it’s been even worse than that for the tech-heavy Nasdaq 100 ever since the turn of the century. I ran those numbers myself, by analyzing the drawdowns of the PowerShares Nasdaq 100 ETF (Nasdaq: QQQ).

Since 1999, the Nasdaq has spent a full 98% of its time in drawdown!

84% of the time, it’s been in a 20%-plus drawdown.

It’s minted new all-time highs just 2% of the time.

That’s rough!

Show me a human investor and I’ll show you an investor who likely gave up and sold out somewhere along that 17-year journey of drawdown agony! (Did you?)

Active investing is often painted as being riskier than passive, buy-and-hold investing. But nothing is further from the truth – particularly when it comes to the risk of abandoning your strategy during a psychologically-trying drawdown.

As I’ve said, you can’t eliminate drawdowns, but you can minimize them. That’s called risk management, and it’s exactly what active strategies, like Cycle 9 Alert, are designed to do.

To prove it, I applied my Cycle 9 Alert algorithm to all 100 individual stocks in the Nasdaq 100 – going back to the same starting point of 1999. And then I’ve compared the performance of my active strategy to the performance of buy-and-hold. Take a look at the results…

As you can see, not only would the active Cycle 9 strategy have produced more total profits over the entire period, it would have done so with milder drawdownsquicker recoveries… and many more “new all-time highs.”

Take a look at this table, which summarizes the amount of time spent in each drawdown category…

All told, my message today is simple.

You must get used to the psychological rub of drawdowns. But you do not have to accept the large-and-long drawdowns inherent in buy-and-hold.

Active strategies, like Cycle 9 Alert, work to minimize drawdowns – both their degree of severity and their duration.

I’m sure you’ll agree with me… living through mild drawdowns is easier than large drawdowns. And making new all-time highs often is easier than waiting year after year to simply get your money back.

To the extent that active strategies minimize drawdowns, they help investors stick to the strategy – which is the key to profitability in the long run.

So the next time you hear someone tell you that passive investing is safer than active investing… set them straight!

And if you’re not already benefitting from the drawdown-reducing feature of active strategies, now is a great time to take a look at my Cycle 9 Alert service.

 

 

 

 

Adam O’Dell
Editor, Cycle 9 Alert
Follow me on Twitter @InvestWithAdam

P.S. Right now we’ve opened up elite-level membership at Dent Research. We only have a limited number of spots available every 12 to 18 months and they’re usually snapped up quickly. As a member of this special group, you gain access to exclusive research from Harry Dent, significant discounts to Irrational Economic Summit, and we pay for your subscription to Boom & Bust. This is on a first-come-first-serve basis. You’ll find all the information you need here.

 

Why Winners Keep Winning (And Losers Keep Losing)

If “buy-and-hold” and the notion that you can’t beat the market have left you short of your personal and retirement goals, then you’re going to want to hear the truth about passive and active investing.

Chances are if you’re more than 25 years old, you think it’s impossible to “beat the market!” But you CAN beat the market… you just need to use the right strategy! Find out more in our new report from Adam O’Dell,, Why Winners Keep Winning (And Losers Keep Losing)!

LEARN MORE
Categories: Investing

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.