My medium-term, trend-following trading methods have had a grueling few weeks this summer.
Unless you’re a forex robot, any run of losses will knock your confidence and lead to questions about what we might be doing wrong.
Often, the answer is simply … nothing .We’re doing nothing wrong, and this is just part of the process.
But, before we hit that conclusion, lets look at some culprits of what else could be going on …
An obvious candidate is … summer. The old “sell in May and go away” saying is based around the predictability of summer markets, when many big-shot traders are sunning themselves in the south of France and volumes get thin.
However, I’ve always been reluctant to make generalisations about which months are “good” or “bad” for trading. A lot of this kind of “wisdom” is based around market growth, which doesn’t necessarily affect those of us who can profit equally well in falling markets. Plus, it’s really difficult to gather enough data year after year on monthly/seasonal performance. There are just too many other variables.
The reality is that drawdowns are all part of trading, and something we have to get used to riding out.
But we can – and should – do more than just grin and bear it.
The emotional rollercoaster that goes hand-in-hand with the ups and downs of our profit curve can lead us into some seriously poor decision making …
So we need a plan of action …
What to do in the depths of a drawdown
There are some things that our brains are screaming at us during a drawdown. Things like …
– I’m throwing good money after bad!
– This method has stopped working!
– I need to give up on this strategy!
– I need to give up on trading altogether!
– I need to radically change this way of trading!
So, what CAN we do …?
1. Examine our trading methods …
What is its track record? Are drawdowns like this normal? By looking at the long-term success rate, you can calculate the probability of a drawdown like this. (Bear in mind that you may be placing hundreds of trades per year, so even a probability of less than 1% can crop up with regularity.)
2. Is this an Achilles heel?
Most trading methods have a weakness. It might be a trend-following method suffering from getting in too late … a breakout system suffering from fake-outs … Are current market conditions triggering these issues? Perhaps there’s a filter that could help keep us out of trades at times like this – we can start testing these extra filters (but don’t rush into making any changes without proper trials).
3. Sit on the sidelines
If conditions aren’t suiting your method right now, how can you reduce risk while you wait for conditions to improve? Consider reducing stakes or demo trading for a week or two.
Yes, this could mean that you miss the start of the next run of profits, but you’ll be well-placed to jump back in quickly.
4. Look at your risk profile.
I often find that traders who are really struggling in a drawdown are over-staking. Look at how much you’re risking on each trade and consider reducing that to avoid overstretching yourself.
Be very cautious of jumping in and out of trading methods. This form of system hopping leaves traders lurching from losing run to losing run, as they chase after the latest hot product.
Instead, hold your ground (even if you’re only demo trading at present) and wait for the next profit surge. That way, you can enjoy the ups as well as stomaching the downs.