Drawdowns are an important part of trading and investing. For example, risk management is all about surviving drawdowns that could prevent you from receiving the rewards on the other side. In “How to Trade During the Stock Market’s Most Dangerous Months,” I use median and average maximum drawdowns as a measure of seasonal risks in the stock market. So, I was eager to read a recent report from Morgan Stanley’s Counterpoint Global Insights titled “Drawdowns and Recoveries: Base Rates for Bottoms and Bounces” (May 21, 2025).
I first heard about the paper on the Animal Spirits podcast, where host Michael Batnick concluded from the research that most stocks are terrible (Batnick also goes into detail on his blog). I came away with a different, albeit related, conclusion: individual stocks are rentals, not soulmates. Morgan Stanley’s research demonstrates that while short-term opportunities exist, the long-term odds for individual stocks are stacked against full recovery. Traders and investors alike need to follow rules for knowing when to let go.
The Grim Math of Drawdowns
Morgan Stanley analyzed more than 6,500 U.S. stocks to measure what happens after large price declines. The results are stark:
- The median maximum drawdown was 85%.
- Over half of all stocks never return to their previous peak after a drawdown (the median recovery stalls at 90% of the prior high).
- The average time from peak to trough was 2.5 years, with a similar period for recovery (a finding that may be outdated because of the Federal Reserve’s modern penchant for rushing liquidity to distressed financial markets).
Moreover, the larger the drawdown, the lower the probability of recovery:
- Stocks that fall 95–100% return to par only 16% of the time.
- Even stocks with a 75–80% drawdown recover fully in just 54% of cases.
- Only stocks that drawdown less than 50% have a reasonable chance—about 80%—of reaching prior highs.
While these base rates rates (historical recovery odds across thousands of stocks) offer a clear note of caution, they are not destiny. Still, these data reinforce my trading approach: treat individual stocks like rentals. The deeper the drawdown, the longer and less likely the road back. Failure to recover with the stock market signals the potential to be stuck without a full recovery.
The Case for Trading Oversold Stocks
Morgan Stanley’s research also highlights a persistent behavioral tendency among retail investors: “Investors are roughly 50 percent more likely to buy more shares of a stock after it went down versus when it went up.” Investors average down to reduce cost basis and boost potential for gains. However, Morgan Stanley references prior research that found that “this behavior did not benefit the investors who averaged down.” Averaging down can increase exposure to companies that are unlikely to recover. The math of drawdowns is unforgiving, and relying on price to return to par can amount to little more than misplaced hope when instead the investor should plan for a strategic exit during whatever recovery the market grants the laggard stock.
Despite the sobering recovery stats, Morgan Stanley makes a key point that resonates with my rules for trading extremes in the market, in this case an oversold market: “The results broadly reveal that the larger the percentage drop in a stock, the greater the percentage bounce.” This potential for outsized gains provides a rationale for buying stocks suffering from large drawdowns — but as a rental and not a long-term holding like a soulmate. These kinds of opportunities are ripe for rental-style positions: defined entries, disciplined exits, and no hope-drenched illusions about a full recovery. My AT50 (for above the 50-day moving average) framework —measuring the percentage of stocks trading above their 50-day moving averages—is a practical and easy-to-use method for identifying a “risk friendly” way to trade these high-reward setups during broad sell-offs.
When to Exit: A Framework for Pruning
We can only know in hindsight which stocks go on to live spectacular post-drawdown lives and which never recover. But accepting that this divide between rentals and soulmates exists is enough to justify a rental mindset. Morgan Stanley offers a set of qualitative questions that traders and investors can use to evaluate companies experiencing drawdowns. These guidelines provide decision points for managing risk and weighing recovery potential:
- Are the fundamental issues cyclical or secular? Many analysts stake their reputations on being able to tell the difference. Yet Morgan Stanley cautions that academic research suggests genuine turnarounds are rare and hard to spot.
- What does the business model reveal? Morgan Stanley notes that “recovery is unlikely if the underlying business proposition is flawed or economies of scale are elusive.”
- How lumpy are the investments in the business? It is easier to scale down small bets. Firms that must invest heavily up front can run into trouble before generating returns.
- Is there sufficient financial strength?
- Is there access to capital if needed?
- Is management clear-eyed about the challenges?
When combined with the technical signals of oversold trading, these questions can sharpen the narrative and discipline around when to hold and when to let go.
Conclusion: Rent Stocks, Don’t Marry Them
Batnick lamented the sustainability of performance for individual stocks. However, rather than abandon them outright, I choose to treat individual stocks as trades, not marriages, rentals, not soulmates. Morgan Stanley’s research shows overall that:
- Most stocks fail to recover from large drawdowns.
- The longer the holding period on stocks which do not recover, the higher the opportunity cost.
- The individual stocks that go on to recover can deliver market-beating returns.
Thus, pruning laggards and cutting losses is a part of the risk management required to survive drawdowns. Do not overstay the hope train waiting on rebounds. If a stock fails to recover with the market, move that money to the market. Rent stocks and return them when they stop working relative to the general market. Don’t fall in love with individual stocks; they don’t love you.
Be careful out there!
Full disclosure: no position