Managing Drawdowns – do you trade through a drawdown?
Today we’re going to talk about drawdowns, trading and drawdowns.
A big topic for traders as I’m sure you understand, so you know. (Watch video here 19 mins)
What is a Drawdown…
- A drawdown refers to how much an investment or trading account is down from the peak before it recovers back to the peak.
- Drawdowns are typically quoted as a percentage, but dollar terms may also be used if applicable for a specific trader.
- Drawdowns are a measure of downside volatility.
- The time it takes to recover a drawdown should also be considered when assessing drawdowns.
- A drawdown and loss aren’t necessarily the same thing. Most traders view a drawdown as a peak-to-trough metic, while losses typically refer to the purchase price relative to the current or exit price.
(Source – www.investopedia.com/)
Draw downs are inevitable.
It’s going to happen, it’s part of life as much as breathing is part of life.
It’s like eating, we need to eat. We need Drawdowns.
But it’s about how you manage it.
There’s not a single strategy on the planet that doesn’t have a draw down.
It’s an absolute fact of life.
But it is about how you manage that and that is what I want to get to grips in this chapter.
In my opinion a REAL drawdown would typically be referred to in institutional trading where the traders are trading proprietary systems and even automated systems, there is limited discretionary input or flexibility – and as a result drawdowns are inevitable to the extent that they could impact the returns on a fund substantially for a time.
It is important to understand that these drawdowns are part and parcel of the strategy – and form part of the whole overall expected results – IF they have been tested properly using statistical data and formulas with in and out of sample data etc – that is a topic alone for a whole book!
But for the purposes of Retail Traders such as you and me – when we refer to drawdowns – it means losing trades!
It is my opinion, that this needs a unique management that is very different to how it is generally taught in the industry.
Where generally the theory that is taught – is to keep trading your strategy through a drawdown. Which is why so many traders ‘blow their account’ and is a ridiculous approach to take.
I have seen the phenomenal impact on many of the traders in the Tribe who have adopted my approach to their trading – so I am confident my approach works! And it works for me!
One of the reasons why my approach is necessary is because the MAJORITY of strategies that Retail Traders trade are not back tested using the approach I mentioned above – hence discretion is required.
Our strategies, POGO & BUGSY have been professionally backtested using our own proprietary platform with statistical and probability formulas and walk forward analysis.
Managing Drawdowns – do you trade through a drawdown?
Over the past couple of years working with traders from around the world, I have seen so many different approaches to drawdowns.
So many ways in which traders deal with it and the impact it has on traders.
Do you have the philosophy that you just trade through a drawdown?
Now trading through drawdowns is something that is often taught, and the industry approach to this truly baffles me.
It baffles the hell out of me.
I’ve had people telling me that they have been taught that the more you trade through drawdown, the greater the trader you’ll be.
To me that approach is actually having zero respect for money.
Zero respect for your capital.
Zero respect for your wealth building.
And that’s on sure way of blowing your account.
There’s a fundamental issue, if you are in a drawdown and you continue to trade in a drawdown, there’s something wrong.
Hey listen, you’re always going to have losing trades.
Losing trades are akin to cost of sales and any business has cost of sales
That’s normal, right?
And ideally where you need to get to is having a consistent success rate in the strategies that you trade – the profitable trades are your sales and your losing trades – cost of sales – and it’s essential as with any business that your sales are greater than your cost of sales!
That is why one of the philosophies in the Tribe of Traders is to master one strategy at a time so you build up a consistency around that strategy.
You know what your success rate is.
Therefore, when you lose trades there is no stress – you know it is part of the process.
Those losing trades are part of the whole.
You lose attachment to having those lost trades, okay, because you know, you understand that they’re part of the whole.
They’re needed in order for you to have your consistent success rate because we all know that you can’t win 100% of the trades 100% of the time. Right?
One of the reasons to get really well acquainted and master one strategy at a time is to get to a point where you have a consistent success rate and move onto the next strategy; a strategy that compliments your previous strategy.
It must all build up to when you’re trading more than one strategy. You want to make sure that it forms part of a portfolio that compliments each other.
Okay, but that was just a side. But back to the drawdowns, there’s absolutely no need to be trading in drawdown.
If you are consistently finding yourself trading drawdowns like losing 12 trades out of 14 trades for example.
Well there’s something awry, all right?
And there’s two things I want you to consider going forward.
One is having a target or a managed target or a way of managing your trading when you’re in drawdown.
So, what I mean by that, have a target. I’m sure you have a target for your monthly trading, like might be four percent, might be six percent, might be nine or 10 or 11% whatever it is, what your target is, equally have a target that you allow yourself to get to each month and no more for your drawdown, right?
That target must never be greater than your monthly target ever.
So if your monthly target is nine percent for example, never trade to a drawdown in a month that’s greater than nine percent ever.
Mine is about three quarters of my monthly target.
And because of the second part of what I’m going to ask you to do is one of the things that helped me massively in managing my drawdowns right back in the early days.
It was a massive breakthrough for me and it’s quite simple.
One, I lose one trade. It’s okay.
It’s part of the whole, right.
Lose another trade, that’s okay.
Lose another trade, this is three now,
Now I’m thinking, okay, what’s going on there?
Because I know the flow, I know how I trade, I know what I do.
It’s the third trade and I was like, okay, what’s going on here?
Now it’s getting beyond the realms of my sort of normal success rate.
So, I’m still asking myself now this one question before I even try to take my next trade, is it me, is it the market or is it the strategy?
They’re the three questions I asked myself and one of the most powerful things I ever learned in life, was from my coach.
My mentor, Dr. John Demartini, the quality of your life is dependent on the quality of questions you ask yourself.
Now, at first, when I heard him say that and he was telling me this, I didn’t understand what on earth he was talking about. Like, what are you talking about?
It just seemed a little bizarre.
But the more I thought about it and the more I did it because I really trusted my mentor and still trust my mentor.
The more I thought about it, the more and the more I did it, the more I could see the tremendous value in doing it.
So asking yourself that question is very powerful – is it me? Is it the market? is it the strategy it?
The more you do it, the more you open that line of inquiry and the more you will be honest with yourself.
It is my opinion that being honest with yourself has got to be the hardest thing to do.
But when you start getting used to asking yourself that question, is it me? Is it the market or is it the strategy?
You’ll start coming up with honest answers.
Is it the market? Can it be the Market?
Well, the market is the market. The market does what the market does. The Market is a massive moving machine.
Something that each one of us has no control over.
It does what it does.
And it’s been doing what it does since biblical days.
If you read the Bible even, there was the foreign exchange, going back to the Bible days.
So it’s been around forever.
And it does what it does very well and very consistently.
But the question is, are you trying to curve a trend-based strategy into a ranging market?
Are you trying to fit a ranging strategy into a trending market?
Are you trying to curve fit your strategy into the market?
So therefore, is it the market or is it you?
And actually, in fact it’s not the market, it’s you, right?
The strategy, let’s look at the strategy, is it the strategy?
One of the things I’ve learned is that there is no shortage of profitable strategies out there to trade.
There’s no shortage of ways in which to make money from the market, which is why I’m totally puzzled by the concept of trading through the drawdown.
I’m amazed that people would think about doing that or teach that because there is no shortage of ways of making money from the market.
So why keep losing money in the market?
That doesn’t compute for me at all.
So there’s no shortage of profitable strategies, therefore, we know that if we’re trading a strategy, we have to know it.
We must know the rules, we have to understand the nuances of that strategy.
We have to trust it and feel confident that either we have back tested it or it has been back tested and it has a consistent success rate.
In Tribe of Traders, we primarily trade two strategies, POGO and BUGSY.
Now consistently month on month, they have an average of an 83% success rate.
So if that is the case, which if it’s not the case, stop right now and get comfortable with your strategy, 100% trust your strategy 100%, to the point that you own it.
That’s a very important strategy. That’s a very important strategy to have about the strategy you trade. You’ve got to own the trading strategy you trade.
Okay? So if that’s the case that you trust the strategy.
You’ve tested the strategy.
And maybe other people are making money on that strategy and it has an average success rate that you’ve seen work then is it the strategy or is it you?
So at the end of the day, with those three questions, it always boils back down to – is it you?
And 99.999% of the time it is going to be you.
You’re the common denominator, the trader.
So, then what are you going to do about it?
That is why I say it’s mindset forward.
Successful trading is about mindset forward.
It’s mindset, first trading second.
The easy thing in the world is to put a trade on the market.
That’s the easiest part of trading.
The actual act of trading is very easy.
It’s not complicated.
But successful trading is all about mindset forward.
It’s all about your state, the beliefs that you’re projecting onto the market.
And when you start understanding that and you start working with that, it’s incredible what happens to your trading.
But right now what I want you to do is, as a lead up to a point where you are confident and have a average success rate, what I’m going to suggest to you is that in order to protect your capital, in order to protect your money, your wealth, your wealth building, which in turn will have a direct impact on you, your confidence, your certainty, your self worth as well, is to have a strategy about how you work with drawdowns.
Okay? My suggestion is lose a trade. That’s okay. Losing the second trade. Okay?
Lose the third trade and consecutively it’s time now to be asking yourself that question, Is it me? Is it the market? Is it the strategy?
I still do that knowing that it’s still going to come back to me.
It’s just important to go through that process.
It leads you back to yourself, right?
What’s going on for you?
What’s happening in your life?
What’s different now than it was last month when I wasn’t in drawdown?
That opens up that line of inquiry.
My suggestion is to have a sliding scale.
What I suggest with the Tribe of Traders is that once they get to a certain point, and everybody will have a point in which this starts to kick in, for some it might be two trades, might be three, might be five, whatever it is for you – My suggestion is less though, because you want to protect your capital.
So have a sliding scale. How many trades?
Let’s say three trades you’ve had drawdown or lost, so do you take the next trade at half the risk, and you lose that one. Then the following trade at half that risk and then the following trades stop and go to demo or what do you do?
Have a sliding scale, so never go more than your monthly target.
In fact, for me, as I said, it’s about three quarters of my monthly target.
Maybe even you could in order to protect your capital, if you’re not getting the success rate you love and protect the capital you’ve got, maybe you want to have it at half your monthly target.
So when before you get to half your monthly target of drawdown, start reducing the risk that you’re taking so you can get back into flow.
It gives you an opportunity to get back into flow.
Gives you an opportunity to ask yourself those three questions and to deal with them.
And so you’re still in the market, so to speak.
And then you start getting back into flow and you start getting more winning trades than losing trades and then you can start increasing your risk again.
Have a strategy around your drawdowns.
Do not just keep trading and ask yourself those three questions.
And the more you ask yourself that question, the more you will understand that it always comes back to you, the trader.
Because trading is all about being mindset forward.
The act of trading is the simplest part of trading.
The successful trading is mindset forward, is mastering your own state, mastering your beliefs, mastering your relationship with money and also mastering your self worth as well and growing your self worth and setting your Wealth Thermometer™ as high as possible.
That’s got to be consistently growing.