How Do You Handle A Drawdown In Trading?
The dreaded affliction which will befall all traders at some point in their careers. Drawdowns are a natural part of our performance, it’s also what constitutes as “natural selection” in the trading world. It weeds out the weak traders.
One of the most important things successful traders aim for is longevity in the markets. So being able to weather through the drawdowns is extremely important to every serious trader.
Small drawdowns are easy enough to handle, it’s the deeper drawdowns that tend to affect a trader’s psychology. If you’re in a drawdown right now, don’t panic. To help you out, here are a few things NEVER to do when you’re on a bad drawdown.
#1 Never Increase Your Position Size!
You’re on a drawdown for whatever reason, it makes no sense to trade even large and risk taking even larger losses.
The reasons for your drawdown could be as simple as market environment not ideal for your methodology, or even your own psychology. Whatever it is, we would expect it to continue until we start seeing some winning trades again.
So in a drawdown, trade smaller, manage risk. Typically a series of small winners will give you the confidence in your methodology again to trade full size.
#2 Don’t Be Too Eager To Get Into The Next Trade
During the drawdown periods, traders will likely have a “fear of missing out” mentality.
Traders may be thinking, “after so many losing trades, the next trade will likely be profitable!”. There’s actually a term for such mistaken logic. It’s called the “Gambler’s Fallacy”.
One truth in the markets also applies to life, is that trends tend to persist. So if you have an established trend of losing trades, it does not make sense to continue doing what you were doing when you started that trend.
#3 Don’t Be Too Quick To Abandon Your Current Trading Methodology
New traders tend to be the ones who experience periods of long drawdowns and are also most likely to abandon the trading methodology.
The reason they jump between methods more easily is because they are inexperienced and have not seen the trading methodology really work. More experienced traders who have seen their trading methodologies work over long periods of time, have great confidence in them and are less likely to abandon it.
If you keep jumping from one method to another, you are not giving the methodology a real chance to show you it works, and you’re also not giving yourself a chance to see if the methodology suits you.
So always reduce your position size, take time to cherry pick your trades and stick to your trading rules. Another very important thing to do in your trading, is to keep a trading journal. It will be unique to you and will be your best friend when reviewing your trading.
Trade well and good luck!