5 top tips to accepting painful drawdowns

Sometimes it can be really tough to love trading.

You put all that time and effort in, but every now and then the market is looking to kick your butt.

For some traders, the markets have been in a serious butt-kicking mood lately.

So, for all those out there suffering from broken hearts trading accounts this Valentine’s day, I thought I’d share some quick tips that may help to ease the pain of drawdowns.

Unfortunately, there’s not much we can do to avoid drawdowns (without breaking the law). As Scott Phillips said in episode 59:

“If you want to avoid drawdowns, stop trading.”

Drawdowns are a part of trading so we have to learn to accept them, but how can we do that?

Well, the first thing is to have the right expectations up front, here’s some advice from World Cup Trading champion Andrea Unger:

“You have to be prepared to live through the drawdowns you experienced in back testing and even a worse one, considering, for example, twice the drawdown as the real limit.”

What if you’re currently in a painful drawdown? There are a few things you can do, here’s a suggestion from turtle-trader Jerry Parker:

“When I’m in a drawdown or losing money faster or more than I think is warranted, I think this is the best rule. It’s really the only rule that is always going to work when you’re losing money. Trade smaller if you’re down 10% and that’s a drawdown that you’re not happy with in the circumstances, then, reduce your position by 20%.

So, have a very draconian rule that prevents you and lessens the chances of hitting another drawdown, 20% for instance that would really make you uncomfortable. It always works and that’s the only thing that works versus more subjective rules.”

Here’s a tough-love tip from Andrea Unger:

“I would advise traders not to look at them. If they make the decision at the beginning, they have to have a plan when they exit the trades, and they need to know, worst case scenario, whether to quit. So they have just to mark it and say “Okay, I have to be advised when this happens, somehow, alarms or whatever,” but to sit and look at the monitor the whole day makes only a bad feeling, so the only thing to do is— you’ve made your decisions? Fine. Place the trades, put your stops and forget about it.”

And if you’re finding it difficult to forget about it, you could try this tip on getting perspective from Nick Radge:

I’m always looking at the performance data of all these top traders. There is a few websites that you can get the performance data.

And I’m looking at the journeys that they have travelled over the last 20, 30, 40 years, and the whole idea of understanding these journeys is that if it happens for these guys, it’s going to happen for me. The more I can understand what they’ve been through, how they’ve kept their head down and keep pushing forward, it gives me faith that well, what I’m doing is right, all I’ve got to do is keep on doing it.

So, whenever I go into a period of drawdown or a little period of uncertainty or personal doubt which still happens, I always refer back to the data provided by many of those managers and reinforce it, that what I’m doing is okay, it will be okay, I’ve just got to get through that next thousand trades kind of thing.

And try not to get caught in the recency bias trap, as Alan Clement explains:

“It’s easy when you look at fifteen-year back test and say “Oh, yeah. Well, it goes from the bottom left-hand corner to the top right-hand corner, so, yeah, I could trade that. No problem.” But what you’re not seeing is if you zoom in, all those little ups and downs and bumps and flat spots that you’re going to have to live through day by day by day.

So, I think it’s very easy to fall into what’s called recency bias, where you’re just focused on the recent returns or the recent results. But, I think, having that larger time horizon is going to give you a much better chance of success. So that’s certainly what I try and focus on.”

So, in summary:

  1. Be prepared to experience larger drawdowns than the backtest reports,
  2. Reduce risk by trading smaller when you’re in a drawdown,
  3. Know the point where you’d stop and until you hit that point just keep placing your trades and forget about the drawdown,
  4. Look at the performance of top traders and the journeys they’ve been through to reinforce what you’re doing is ok,
  5. Don’t focus on the short-term results, consider the long-term horizon.

And to wrap this up, some final words of wisdom from Jerry Parker:

“I would say the most important thing is to embrace the systematic approach and really believe that you don’t know where the markets are going.

 You’re going to be much happier at the end if you just totally 100% embrace systematic trading and by following your system and understanding that if you follow the system, that’s the right or wrong, not giving the money back or taking a loss.

 You weren’t wrong if you took a loss, you weren’t right if you made money. You just follow the system to a degree that you follow the system… 

 So, sell your soul, sell out to the trend and to systematic trading, realizing that you really do not know where the market is going. You can’t do any better than your system.”

Happy trading,

PS. Another important tip to managing drawdowns is having a clear process on how to handle strategies that are performing poorly. Bob Pardo from Pardo Capital shares how he manages trading strategies in the Building Robust Trading Strategies Masterclass. You can find out more about the program here.

Happy trading,


14 February 2018

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