Compounding is usually sold to you in one direction. Money grows on money, small returns stack into large ones, and the chart in the article curves gently upward toward retirement.
All true. But compounding is a mechanism, not a cheerleader, and it runs just as efficiently downhill. The part beginners almost never see is that losses and gains are not symmetrical – and once you understand exactly how unfair that trade is, a lot of confusing advice about risk suddenly makes sense.
The number that surprises everyone
Lose 50% of your account. How much do you need to make back to get to where you started?
Not 50%. 100%.
If £10,000 falls to £5,000, a 50% gain takes you to £7,500 — still a third short. To get back to £10,000 from £5,000 you have to double your money.
This isn’t a quirk of that one example. It happens at every size, and it gets worse fast:
| You lose | You need to gain to break even |
| 10% | 11.1% |
| 20% | 25% |
| 30% | 42.9% |
| 40% | 66.7% |
| 50% | 100% |
| 60% | 150% |
| 70% | 233% |
| 80% | 400% |
| 90% | 900% |
Notice the shape. Small losses are nearly fair – a 10% dip needs an 11% recovery, close enough that it barely registers. But the curve bends sharply somewhere past 30%, and beyond 50% it goes nearly vertical.
The reason is simple once you see it: a percentage is always measured against what you have now, not what you used to have. After a loss you’re working with a smaller base, so every future percentage buys less ground. Losses shrink the engine that has to do the recovering.
That’s the whole idea. It’s not advanced maths – it’s just the arithmetic nobody puts next to the growth chart.
Order matters, which shouldn’t feel possible
Here’s the consequence that trips people up.
Suppose you make 50% one year and lose 50% the next. Two returns, one up, one down, same size. Sounds like a wash.
£10,000 → £15,000 → £7,500.
You’re down 25%. And it doesn’t matter which order you put them in: lose 50% first and you get £5,000, then gain 50% for £7,500. Same answer.
Multiplication doesn’t care about order, so a year of +50% and a year of −50% is always a loss. Not because you were unlucky — because that’s what those two numbers do when you multiply them.
Why “average return” quietly lies
This is where a lot of beginners get misled by perfectly honest numbers.
Take the two years above. The average of +50% and −50% is 0%. Nothing happened, apparently. But you actually lost 25% of your money, which works out to about −13.4% a year, compounded.
The average return and the return you actually got are different figures, and the gap between them widens with volatility. A steady 7% a year and a wild ride averaging 7% a year do not end in the same place — the wild ride ends lower, every time, purely because of the maths above. Practitioners call this volatility drag.
So when you’re comparing two strategies, two funds, or two years of your own results, the average annual return is the least useful number in the room. What you want is the compound growth rate, and next to it the worst fall along the way.
Max drawdown: the number that predicts whether you quit
That worst fall has a name — maximum drawdown. It’s the largest peak-to-trough drop over a period, and it answers a question that returns alone never do: how bad did this get on the way to that result?
Two strategies can both finish the year up 20%. One drifted up steadily. The other was down 45% in March. On paper they’re identical winners. In practice almost nobody survives the second one, because at −45% you’re not looking at a spreadsheet — you’re looking at a number that needs an 82% gain just to get level, wondering whether the plan was ever any good.
That is the real cost of a deep drawdown, and it’s not financial. It’s that the drawdown is what makes people abandon the plan at exactly the wrong moment, converting a temporary paper loss into a permanent one. The maths says you need 82% to recover. Human nature says you won’t be there to collect it.
Which is why max drawdown deserves to sit right next to the return in every comparison you make.
Find your number before it finds you
Here’s the practical part, and it’s more doable than most beginners assume: for anything rule-based, you can measure your worst drawdown before you risk any money.
If your approach has actual rules — buy this, sell that, size positions this way — you can run those rules against historical data and read the result. That’s backtesting, and it’s not the exotic professional thing it sounds like. Tools like fxbacktest.app let you replay a strategy across years of past market data in a browser and hand you back the numbers that matter: the compound return, the win rate, the average win against the average loss, and the deepest hole the strategy ever put you in.
That last figure is the one to look at first. Not because it predicts the future — it doesn’t, and the future will eventually produce something worse than anything in the sample — but because it tells you what this approach is capable of doing to you in a bad stretch. A strategy whose worst historical drawdown is 15% is a different proposition from one that once went to 55%, even if their returns match exactly.
And if the answer is uncomfortable, you’ve learned it for the price of an evening rather than the price of an account.
The same logic works without any software at all for slower decisions. Before you commit to a portfolio, look up what it did in 2008 and 2020, not just what it averaged. Before you count on a side income, look at your own worst quarter, not your best.
What to actually do with the number
Once you know your likely drawdown, you have a decision you can act on:
- Size positions so the bad case is survivable, not just the good case profitable. Most beginners size for the outcome they want. Size for the drawdown instead, and the returns take care of themselves.
- Refuse to go near the steep part of the curve. Everything past about 30% is where recovery stops being realistic. Treat that as a hard boundary, not a worst case you’d cope with.
- Write down what you’ll do at your expected worst point, before you get there. “If I’m down 20% I hold, because the plan expects that” is a decision you can only make calmly in advance.
- Compare on drawdown, not just return. Between two strategies with similar results, the shallower one is genuinely better, because it’s the one you’ll still be running in a year.
