Trading Drawdown

psychology Mar 25, 2024

All traders understand that a loss is unavoidable. Taking two losses back-to-back is likely. After three losses in a row, especially on the same pair, a trader generally has two paths to take:

Option A) Take a step back from trading, preserve capital, and wait for the market to show a better sign correlated to your trading plan or,

Option B) Continue to force trades (this is FOMO/GREED/EGO driven decisions) which can quickly turn into three or more consecutive losses, ultimately leading to double-digit losses.

Without a doubt, we want to be the trader that chooses the divine path of Option A but at one point or another, you will find yourself in a drawdown that not only brings you to question the strategy or trading plan, but yourself included – “am I meant to trade?” “Maybe trading isn’t for me?”. No worries, because you are NOT alone: ALL TRADERS HAVE ALREADY OVERCOME, OR WILL EXPERIENCE DRAWDOWN at some point in their trading career.

First off, What is a “drawdown”?

So you’ve had a few negative months, heck, maybe even a couple of years and been unable to get yourself out of the red. Welcome, to a reality of trading: drawdown.

In trading and investing, drawdown refers to the peak price to the lowest price of the account value in percentage. Example: if a trader started off with a $10,000 dollar account and is currently sitting at $9,000, then the drawdown of the account is 10% (1% = 100).

No matter what system you trade, a losing streak is bound to happen. It is a mathematical probability of trading. Like all businesses, there are costs. Consider drawdown as a part of the cost of running your successful trading business. If we don’t handle trading like a business then failure is right around the corner. The goal is to keep your losses minimal to stay in the market longer to be able to trade another day. There comes a time in every trader’s journey where they will experience drawdown, and it’s perfectly normal. We are human. It’s okay.

The next question is: How to overcome a trading drawdown?

Now that we understand that drawdown is a natural part of trading, overcoming the crucible of the market is what makes the trader who they are. After you come back from a -10% month or more, a trader will have a newfound confidence.

Consistent traders embrace drawdown, understand the probability model of their strategy and know that drawdown is only temporary. Use drawdown as an opportunity to refine your strategy if losses continue to amplify after the market cleans up. Use the time of drawdown to improve in the areas you can. There is always something you can learn if you ask the right questions. Here are a few things that have helped me during periods of drawdown:

1: REGAIN CONFIDENCE BY GOING OVER RECENT WINNERS & LOSERS

If you are feeling stuck try this exercise:

– Go over your last 3 winning trades. If you only have losses lately, find THREE of your latest winners and ask yourself questions along these lines:

– “Why did this trade work?”

– “Why isn’t this style working now?”

– “Has market conditions changed since then?”

– “What could be changed to make this position more profitable?”

– etc… (ask similar questions that resonate with you to gain that gain the most value)

The goal of asking questions about your winners is to foremost, regain confidence in your trading ability and secondly, condition your mind that there can always be something to take away from a trade. Knowing why winning trades were a success can help nudge your confidence just enough to get you back to a comfortable state of trading.

After going over at least 3 winners, turn your attention to losses. Take a look at three losses across different pairs. Avoid looking at back-to-back losses on the same position. The more variety of pairs, the easier it is for you to gather information on overall market conditions (corrective or trending).

Now, do the same thing as we performed with winners;

Ask your self-similar questions:

– “What type of market are you currently trading (corrective or trading)?”

– “Why didn’t this trade work?”

– “Has market conditions (corrective or trending) changed?“

This exercise of finding 3 recent winners and 3 recent losses will help you understand and regain confidence in knowing what you are doing (or not doing). It may help you discover something you were missing because, in regards to trading, our ego can be blinding potential opportunities or contradicting a patient mind instead of staying out and waiting for proper set-up, we rush and force a trade.

2: BACKTEST YOUR STRATEGY

Re-analyze the market; Use software that enables you to “rewind” time, or the same thing you use to backtest. Tradingview has backtesting software built into their charts analysis – called “replay“.

The purpose of going back to the time is to take a look at your entries and take another look at the possibilities that could have happened. Identify patterns, what are you seeing? Can you recognize them effortlessly? Remember the patterns. Remember to trust yourself and your analysis. Learn from your mistakes.

Why backtest? To make sure your strategy is still profitable during uncertain times. Maybe your trading style has to change a bit. Maybe you trade could have held for longer and squeeze more profit safely. Or, maybe letting the trade run in a certain scenario wouldn’t be advisable and instead, a take profit is more lucrative. This all comes down to the individual and how they trade but the only way you’d know what your style is or how to adapt through market conditions is to backtest your strategy and come out with a profit.

Backtesting your strategy will also show how much drawdown/losses should be expected. Instead of applying an emotionally driven trading plan be sure it is a risk management-driven plan. The longer you are in the market, the higher probability of becoming a successful, full-time trader is plausible.

3: TAKE A BREAK FROM THE CHARTS

For some traders, taking a 15-minute chart-check can become a time-warp. Suddenly, hours have gone by with no exciting activity or worse yet, you’ve dug a deeper hole in your account. Don’t be a cavity to your trading account, one that constantly digs deeper and becomes corrosive. More trading doesn’t always mean more profit. Yes, the Forex Market is very lucrative on a daily basis, however, that doesn’t mean your strategy will always have an opportunity. Again, everyone’s trading plan is different, but stick to what you know. If you’re confident with your plan and know that it generates profits year in and year out, but you’re still not pulling profit, take a break!

In this very “productive” society, as a trader, mandatory screen breaks help clear the mind. Find a hobby that releases endorphins and gets the blood flowing. A workout, lifting weights, gently walk outside, can be a game-changer to your trading game.

Remember to take screentime breaks – 15minutes or more, up to a minimum of 3 times daily.

The key is to completely forget about trading for that short time. Don’t read trading books, or look at other traders’ ideas. Find the present moment in nature or a quiet corner of your room.

Another way to take breaks can be for longer periods between placing a trade. Instead of trading the normal volume, take a step back and trade less – Not to be confused with not checking the charts. Check the charts! but, avoid placing any positions – take a rest, regain confidence.

OKAY, NOW WHAT?! So you followed these three steps yet, you’re still in drawdown. Or you got out and are back in a dip of red. A reminder that If you were able to recover once, you can recover again.

Let’s be blunt. The truth you have fallen into drawdown again is because you allowed it to happen through emotional trading. I know because I’ve been there countless times. In 2017 I had 8 losses in a row. In 2018 I had two poor performances with 17 and 15 losses in a row, in two single calendar months. Our trading performance is a result of our mindset. You need to accept that you are in charge of your trading future.

Take responsibility. Stop jumping course to course, mentor to mentor without first shutting influence out and listen to yourself and the plan you know that succeeds. Many quit too early. As the saying goes “the only trader that fails is the trader that gives up.” Overcome the drawdown. So what if you’re there again, you can rise again. Now you’ve overcome another drawdown with ease. Loss equals growth if you let it. It Doesn’t matter how many losses in a row you take.

Overall, There can be many reactions to drawdowns but traders usually end up doing one of two things: overtrading (being aggressive to get the money back), doubling down (revenge trading) risking double your risk or placing no stop loss. Even if its’ far above and away from your entry, always place an SL, ALWAYS! perform backtesting and get accurate statistics of what needs to be amplified or regressed.

You have to make mistakes to grow. it’s okay to have multiple losses in a row because if your plan and risk management is correct, one trade can make up for all those loses, and vice versa.

Profits are great but losses are real and if handled correctly, should be lessons.

The main point of this post is to illustrate that drawdowns do occur and they can be rough on a trader’s psyche. The only way a trader can get beyond it is actually to experience it which is why I would highly emphasize start trading with a little more capital that makes you feel unformtable if you loose but have also accepted and won’t finiacnailly ruin you. In the end, it’s how you handle these periods of drawdown that will make or break you.

Trust the process and execute cleanly on your backtested plan, dont overthink in between – hit the gym or go for a run whenever you feel the overthinking coming along.

ABOVE all, never ever give up if you really want to become a successful-consistent-full time trader. As Michael Jordan puts it so elegantly “I’ve failed over and over again in my life. And that is why i succeed.”

Happy trading all.

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