Understanding and Dealing with Drawdowns
- Date: 2007-07-08 - Word Count: 664
Share This!
We all have it and go through it one time or another and will continue to go through it. For others, drawdowns are more common than profit run-ups. Or worse, each drawdown is worse than the last. It's a never-ending cycle where these holes appear in our equity charts or account statement. How does a trader go about understanding and coping with them?
The main problem with drawdowns is that the majority of the traders don't know they exist and have ignored them. They have only calculated how much they will make and what they will do with that money earned. But little thought is given to how much each trade would bring and by how many losing trades it takes to wipe out the account. Those without a trading plan or a strategy will have no idea what their expected drawdowns will be. Only after they lose it all did they realize they need a plan to deal with losses.
First is to formulate a strategy and test and demo trade that strategy in a consistent way. Once that's done, start demo trading and begin keeping record and calculate all the losses, wins percentage plus countless other statistics to give an idea how the strategy fares. These demo accounts are offered free by many brokers. Among all of these ready-made calculations from the trades, there is a calculation for accumulated losses as well as average loss per trade. These two formulas show a strategy's likeliness to losing periods and by how much, either in terms of consecutive losing trades or the loss since the highest equity amount. When knowing this in advance, we can expect it in the near future and not be tempted to doubt and even abandon the strategy when in fact it's a profitable system in the long run. Most will never know because they cannot look beyond the current drawdown as part of the overall strategy. This is why testing and reviewing the strategy performance results is such an important part of trading, not just trading. This is where mechanical traders have an edge by following through a process of taking an idea into a final live trading phase.
Drawdown happens to everyone and can happen at anytime. Whether it's caused by the strategy itself or by the trader's own psychological and emotional issues, drawdowns is a fact of trading life. The only way to deal with it is to prepare for it and if possible, identify it and keep it to the minimum. This can be accomplished by reducing the size of the position, trade less or be more vigilant and cautious on each trade.
Drawdowns are the biggest reason why most people cannot survive trading because of the emotional stress that comes with them. These are moments when the trader is truly tested, some overcoming it by continuing and staying with the strategy until the drawdown in finished. Most, however, come undone by doubting their system and lose self-confidence as a trader. Eventually, these traders move on to other systems that will eventually go with their own drawdowns, which spiral to more losses, losing more equity. It's a vicious cycle where the biggest damage is not monetary but psychological. Eventually, these traders cannot handle the stress and quit.
Having explained the consequences of a drawdown, this is why it is so important to concentrate on finding the historical drawdowns associated with the strategy before trading them. This will prepare the trader to expect and deal better with the losing streak. When a person expects and prepares for the worst, he usually comes out feeling better mentally, especially when the result is not as bad as expected.
This mental state has to be nurtured and watched constantly during this period. More important than losing money is the loss of objectivity and confidence. So when this period does arrive, monitor and pay closer attention to each action and mental thought. In doing so, it will lead the trader out of the drawdowns with confidence intact.
The main problem with drawdowns is that the majority of the traders don't know they exist and have ignored them. They have only calculated how much they will make and what they will do with that money earned. But little thought is given to how much each trade would bring and by how many losing trades it takes to wipe out the account. Those without a trading plan or a strategy will have no idea what their expected drawdowns will be. Only after they lose it all did they realize they need a plan to deal with losses.
First is to formulate a strategy and test and demo trade that strategy in a consistent way. Once that's done, start demo trading and begin keeping record and calculate all the losses, wins percentage plus countless other statistics to give an idea how the strategy fares. These demo accounts are offered free by many brokers. Among all of these ready-made calculations from the trades, there is a calculation for accumulated losses as well as average loss per trade. These two formulas show a strategy's likeliness to losing periods and by how much, either in terms of consecutive losing trades or the loss since the highest equity amount. When knowing this in advance, we can expect it in the near future and not be tempted to doubt and even abandon the strategy when in fact it's a profitable system in the long run. Most will never know because they cannot look beyond the current drawdown as part of the overall strategy. This is why testing and reviewing the strategy performance results is such an important part of trading, not just trading. This is where mechanical traders have an edge by following through a process of taking an idea into a final live trading phase.
Drawdown happens to everyone and can happen at anytime. Whether it's caused by the strategy itself or by the trader's own psychological and emotional issues, drawdowns is a fact of trading life. The only way to deal with it is to prepare for it and if possible, identify it and keep it to the minimum. This can be accomplished by reducing the size of the position, trade less or be more vigilant and cautious on each trade.
Drawdowns are the biggest reason why most people cannot survive trading because of the emotional stress that comes with them. These are moments when the trader is truly tested, some overcoming it by continuing and staying with the strategy until the drawdown in finished. Most, however, come undone by doubting their system and lose self-confidence as a trader. Eventually, these traders move on to other systems that will eventually go with their own drawdowns, which spiral to more losses, losing more equity. It's a vicious cycle where the biggest damage is not monetary but psychological. Eventually, these traders cannot handle the stress and quit.
Having explained the consequences of a drawdown, this is why it is so important to concentrate on finding the historical drawdowns associated with the strategy before trading them. This will prepare the trader to expect and deal better with the losing streak. When a person expects and prepares for the worst, he usually comes out feeling better mentally, especially when the result is not as bad as expected.
This mental state has to be nurtured and watched constantly during this period. More important than losing money is the loss of objectivity and confidence. So when this period does arrive, monitor and pay closer attention to each action and mental thought. In doing so, it will lead the trader out of the drawdowns with confidence intact.
Related Tags: stocks, day trading, investing, newsletter, technical analysis, swing trading, swing trade
Larry Swing CEO & Head Swing Trader swing trading with mrswing.com theboss@mrswing.com +1 (281) 968-2718 Yahoo & Skype ID: larry_swing Your Article Search Directory : Find in Articles
Recent articles in this category:
- The Secrets to Getting Low Down Payment Car Insurance
Upon purchase of a new car, there is almost always a requirement to buy an auto insurance policy as - The Wisdom Behind Auto Insurance Comparison Quotes
No one in his right mind would not go for a good deal. In fact, everyone is out on their feet and ru - The Benefits of Auto Insurance Comparisons Florida
Insurance can be expensive. This is something everyone knows about especially in the sunny state of - Auto Insurance Florida: The No-Fault Policy
There are different kinds of car insurance offered by a wide range of providers today. Different sta - Finding the Cheapest Auto Insurance Companies
Everyone is asking and searching for the cheapest auto insurance companies available today. Consider - How do You Compare Private Health Insurance Cover in Australia?
Deciding what is the best and most affordable private health insurance cover can be easy if you take - How Payment Protection Insurance Was Mis-Sold
For over six years the issue of Payment Protection Insurance (PPI) and how it was mis-sold to custom - Finding Quotes For Auto Insurance Online
One of the many concerns when you are shopping for auto insurance is being able to get access to quo - How You Can Find the Best Auto Insurance Online
When it comes to renewing your car insurance you are going to quickly discover that there are a numb - Guidelines For Searching For Auto Insurance Online
The internet can be a great source of discounts and values related to auto insurance. However, many
Most viewed articles in this category:
- Trading Forex With Pivot Points
Forex Pivot Point Trading are used today by Forex Traders and are calculated on the previous days mo - Where To Search For Free Grants
Where do you look for free grants? The search must be thorough or it could be an exercise in futilit - The Connection Between High Blood Pressure and Salt
We are a society of Salt Addicts. It cannot be denied. When you look at the things we do and the pla - Tips For Avoiding HYIP Scams
Before knowing about HYIP Scams, refer to the functioning of HYIP or "High Yield Investment Programs - Getting Credit After Bankruptcy
Consumers do not have to live sans credit following a bankruptcy. By following certain steps consume - Tips For Choosing A Credit Card
Are you looking for that perfect credit card? If so, you may be confused about what exactly to look - Cheap Car Insurance For Teens Online
Many elements determine a car insurance policy. Car insurance companies look at the person's age, hi - What Exactly Is Free Grant Money?
You can apply for free grant money from various government agencies. But where exactly does this mon - Small Business Owners Marketing and Customer Service
Marketing can be time-consuming, but it doesn't have to be hugely expensive now, thanks to the Inter - Apply Online For A Credit Card - How To Choose A Card?
The best type of credit card for you will be dependant on how you intend to use the credit card. Are