Most traders approach drawdown as something to endure. Scott Phillips approaches it as something to understand. His framework for reducing drawdowns starts not with risk management techniques but with identifying what type of market you are actually in, because the same setup that works brilliantly in one market type will destroy capital in another.
Scott Phillips’s background is unusual. He spent the first decade and a half of his adult life as a drug addict and criminal, including a prison sentence in 2006. In prison, he read every trading book he could access and had people phone in open, high, low, close data so he could draw his own charts. After his release, he blew up two accounts, rebuilt his approach from scratch, and eventually developed a systematic methodology that has held up across different market conditions. In episode 59 of the Better System Trader podcast, Scott shares his six market type framework, his rapid prototyping technique for killing bad ideas fast, and how multiple exits can reduce drawdown without sacrificing returns.
Watch the full episode below, then read on for the complete breakdown.
The six market types and why they matter
Scott describes market behavior using a simple matrix: three directional states (bull, bear, sideways) combined with two volatility states (high and low), producing six distinct market types. His central argument is that markets behave almost completely differently across these types, and trading systems designed without accounting for this will produce inconsistent results.
A low volatility bull market, which describes US equities broadly from 2010 through the mid-2010s, is characterized by steadily rising prices with small counter-moves. Counter-trend setups fail repeatedly in this environment. Traders who kept shorting technically perfect patterns kept losing, not because the setup was wrong in principle, but because the market type made counter-trend trades a low-probability bet regardless of pattern quality.
A high volatility bull market, by contrast, is usually the end phase of a trend. The 2001 dot-com top, the 2008 oil bubble, and the 2017 Bitcoin run all followed the same structural pattern: accelerating gains with widening swings. This is a fundamentally different trading environment from a steady low-volatility uptrend, even though both are classified as bull markets. Trying to pyramid into a high volatility bull market using the same approach that worked in a low volatility one is a reliable way to give back profits.
The market type Scott finds hardest is low volatility bear. The last months before the March 2009 bottom were choppy, overlapping price action that dropped in an unsatisfying, grinding way. His assessment: barely worth building systems for. The reward-to-effort ratio in that environment is too poor.
Candlestick patterns have zero edge
Scott is direct about one of the more popular areas of technical analysis. He tested every Steve Nison candlestick pattern from the major books and found no tradable edge anywhere in them. His conclusion was unambiguous.
“There’s not a baked bean worth of useful or tradable information. There’s zero edge.”
His broader point is that the internet contains substantial disinformation on trading setups, often published by people who never traded with real money. The statistics that appear on websites about pattern win rates are frequently fabricated or calculated from cherry-picked samples. The only way to know if something works is to test it yourself, with your own data, against your own rules.
Rapid prototyping with 100 manual trades
Scott’s answer to the problem of testing too many ideas too slowly is a rapid prototyping technique that requires no software. He uses pen and paper with three columns: win, loss, and break even. He marks 100 trades manually on historical charts, using hash marks to record the outcome at four fixed exit levels: 1R, 1.2R, 1.5R, and 2R.
To prevent selection bias, he picks random starting points in the data. Sometimes he closes his eyes and clicks the mouse arbitrarily. Sometimes he asks someone else to navigate to a random chart position. The goal is to see representative results, not curated ones.
A system with real edge should show positive total R across all four exit levels, not just the optimized one. If a system looks good at 2R but fails at every other level, something is wrong. Genuine edges tend to produce decent results across a forest of reasonable parameters, not a single optimized spike. The 100-trade manual test is designed to identify and discard bad ideas cheaply, before investing time in formal backtesting.
Multiple exits to reduce drawdown without reducing returns
One of Scott’s most practical contributions to reducing drawdown involves using multiple exits rather than a single target. His finding is that splitting a position across different exit levels can improve the ratio of net profit to maximum drawdown in ways that a single fixed-target system cannot achieve.
The logic is straightforward. A system with a single exit at 2R will produce larger drawdowns when the market goes through a run of trades that get close to the target but do not reach it. A system that takes partial profits at 1R and holds the remainder for 2R will capture more of those near-misses while still participating in the larger wins. The blend smooths the equity curve in a way that neither exit alone achieves.
This also allows him to optimize for a specific metric, typically the net profit to maximum drawdown ratio, rather than just maximizing net profit. In his experience, the ratio is the more meaningful measure of whether a system is actually tradable under real conditions.
Inside day as a lower timeframe trading range
Scott looks for objective definitions of classical patterns rather than the ambiguous descriptions found in most technical analysis literature. His example of what this means in practice is the inside day.
An inside day is simply a day where the high is lower than the prior high and the low is higher than the prior low. It is completely objective, with no room for interpretation. But what it represents structurally is a lower timeframe trading range. An inside day on the daily chart is essentially a 60-minute trading range that has persisted throughout the entire day. It will eventually break in one direction or the other, and the direction of the breakout has more predictive value when the broader market is in a trend.
This framing, connecting a higher timeframe pattern to what it means on a lower timeframe, gives him a clear invalidation point and a logical reason to take the trade.
Building a toolkit of 13 setups, each with an objective definition
Scott’s full methodology uses approximately 13 different setups, each of which has an objective, mechanical definition that removes subjective judgment from entry decisions. The inside day is one. The faker setup, his version of a double top, is another: a spike high followed by bars that fail to break that high, then a bar that does break it, followed by a short entry if price opens in range and breaks the daily low.
The point of mechanical definitions is not to eliminate discretion entirely but to ensure that what is called a pattern actually has consistent properties. The classic Edwards and Magee charting methods describe patterns that can be identified in dozens of different ways, making backtesting essentially meaningless. You cannot test a setup that depends on the reader’s judgment about what constitutes a valid example. His definitions remove that ambiguity.
Robustness as the primary criterion for keeping a system
A real edge should work across multiple markets, not just one. If someone presents a system that works on gold but not on bonds, or works on daily charts but not on weekly, Scott treats that as evidence the edge is fragile. True edges in price behavior reflect things that happen across markets and across timeframes, because markets are ultimately driven by human behavior and human behavior does not change based on which market or which timeframe you are observing.
This robustness test is built into his rapid prototyping process. Before a setup gets promoted to formal backtesting, he wants to see it work across several instruments with the same basic entry logic.
Related episodes
- 5 Top Tips to Accepting Painful Drawdowns
- Managing Multiple Trading Strategies: portfolio design, drawdowns, and position sizing – David Bean
- Market Behavior – Adam Grimes (Episode 55)
- Risk Management – Robert Carver (Episode 70)
Get the show notes & transcript
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