A draw down is a normal occurrence for a trader. Swing traders experience them at times in markets that break out of trading ranges and trend, trend traders experience them in choppy or range bound markets, day traders experience them in markets that whip saw violently, and growth investors experience them in bear markets and corrections. the key to surviving them is staying disciplined in your entries and exits. Only take valid entries and always cut your losses at predetermined spots where you are proven wrong. If you are gunning for high returns then you can expect draw downs that are about half your return rate. If a trader is disciplined and trading a winning sytsem then a draw down is simply a result of the market environment not being conducive to the traders method and system, it is not an indictment of the traders ability if they are taking their entries and exits according to their trading plan.
The question is: “Where will your account be with a string of 10 consecutive losses?” Some traders will be out of business, others will be down 10% from their equity peaks. The truly naive or arrogant trader will think that 10 straight losses will never happen to them. Even with very high winning percentage system they may not have ten straight losses it may just be one really big one.
Here are 7 steps to limit the pain of draw downs:
- When losing in trade after trade, lower your trading size by 50%. Trade smaller until a winning streak begins. Go even smaller if needed or even take a break from trading.
- Only risk 1% of your capital per trade. While this is standard, you must avoid the temptation to trade big to make up your losses. This usually compounds the problem because the market is not co-operative with your style during a down trend.
- Stay disciplined with your entries and exits. Do not get sloppy.
- Do not abandon your method, you have to stay the course so when your method comes back in favor you will start winning again.
- Do not take losses personally. It is not your fault that the market is not conducive to profits if you are trading your proven system.
- Do not fall into the temptation to let losers run. Cut your losses at predetermined stops regardless of the pain.
- Do not stop tracking your watch list for the markets you trade, be ready to take the right entry when it presents itself. Many traders get so beat up on a string of losses that they stop focusing on their watch list and stop taking high probability entries. You hav eto be ready to jump back on the boat when it is ready to sail again, just don’t drown while your waiting on the shore.
“Where you want to be is always in control, never wishing, always trading, and always first and foremost protecting your ass. That’s why most people lose money as individual investors or traders because they’re not focusing on losing money. They need to focus on the money that they have at risk and how much capital is at risk in any single investment they have. If everyone spent 90 percent of their time on that, not 90 percent of the time on pie-in-the-sky ideas on how much money they’re going to make. Then they will be incredibly successful investors.” -Paul Tudor Jones