How to Emerge From a Trading Drawdown

Trading can really suck sometimes.

Especially during those times where everything you touch turns out to be wrong. Those dark periods are part of the business, and unfortunately, it’s just a matter of time before you find yourself in the next trading drawdown.

Recently I found myself in a very challenging environment. Choppy price action and quick shakeouts with no follow through.

I was booking nothing but a series of small losses, one after another, and not enough large winners to offset positively.

It’s time likes these, that one of my all-time favorite trading quotes makes its way to a post-it note stuck square on the middle of my desk for the month.

Never let a good drawdown go to waste

I love that quote. There’s so much wisdom packed into that simple sentence.

It reminds us that, not only do we need to learn how to accept drawdowns, but we must learn how to embrace them, and use them as an opportunity to emerge stronger and smarter than before.

Have a review process

The next time you find yourself in a trading drawdown, try implementing a review process. It’s easier said than done, but coming up with a list of questions ahead of time can really help.

Here are some of the questions I ask myself:

  • Is my strategy performing as expected given the current market environment?
  • Has anything changed that invalidates my strategy / edge?
  • Is there something I’m doing wrong? Have I broken any of my rules?
  • Are these losses reasonable? Do I need to revisit my risk management rules?

By answering these questions I’m trying to determine if this is expected volatility in my trading system, or if something has changed in the way markets are behaving that my system wasn’t accounting for.

Generally, this review process leads to one of two outcomes.

  1. Slight tweaks to existing rules, nothing major, simply some housekeeping or optimizing.
  2. Renewed confidence. Nothings wrong, the system is behaving just as I expect given what the market is throwing at it. Go out there tomorrow and execute without hesitation.

The less likely (hopefully) third outcome would be the realization that something is, in fact, wrong with the trading system or our personal execution.

If this is the case, take a break from trading, and go back to the drawing board.

Identify what is causing problems and plug that leak before getting started again.

 

How to Emerge From A Trading Drawdown Image of Research

Research & development

When I find myself in a trading drawdown, I actually find diving into research very helpful.

Research could mean conducting some backtests, reading a new trading book, reviewing old trading notes, anything to get my mind off the current challenges and into new ideas.

This research may never find its way into my live trading, but more often then not it will help me ride out difficult times, and sometimes, spark some small adjustments.

How to emerge from a trading drawdown

We’ll never be able to eliminate drawdowns from trading.

There are always going to be periods where we lose money due to normal volatility and occasionally from our own foolish mistakes.

Accepting this means that we need to be comfortable with some sort of review process that helps us identify and plug leaks when they surface.

The goal in that process is to make sure we never make the same mistake twice, and most importantly, never let a good drawdown go to waste.

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Evan Medeiros

Evan is the founder of The Trade Risk, a financial media company that publishes research and analysis about the stock market and specializes in trading education. With 20+ years of coding experience and a B.S. in computer science, Evan brings a systematic discipline to investing in the stock market.

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4 Comments

  1. […] August 6, 2016 ~ rohiniglobal Never Let A Good Drawdown Go To Waste […]

  2. […] How to emerge from a trading drawdown – The Trade Risk […]

  3. Ray Dossat on 2:22 pm January 6, 2018 at 2:22 pm

    Evan,

    Thanks for this reminder, I am currently just losing, so I’m taking a breather to reevaluate. One question is do you have a set percentage on you stops for the loss?Seems like you are anyway from 3 to 5 % max on your open trades and stops? Is there a specific rule you have for percentage?

    Ray Dossat, new subscriber

    • Evan on 3:28 pm January 6, 2018 at 3:28 pm

      Hey Ray,

      Breathers to evaluate is a solid step in the right direction. Most traders keep digging in, doubling down, revenge trading, etc. so nice job short-circuiting that vicious cycle.

      So in terms of stop losses, I do not have a set distance rule, instead, every trade gets evaluated individually.

      First and foremost, a stop loss should always be placed at the point at which the underlying thesis for entering the trade becomes invalidated. For example, if we’re playing for a breakout trade in stock ABC above $50, then, generally speaking, if ABC starts closing back below that breakout level (the original reason for entering) then we no longer want to be involved.

      So that line of thinking gives us the general “placement” of a stop and it’s applicable to Breakouts, Pullbacks, Reversals, Trends, etc.

      However, as swing traders who are holding stocks overnight, there is an additional step of incorporating some extra risk management layers to protect us against overnight risk.

      Check out this page: https://www.thetraderisk.com/position-size-calculator and this post: https://www.thetraderisk.com/how-to-position-size-when-swing-trading/

      I hope this helps, keep working at it!

      Evan

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