So you've opened and funded a trading account. You've studied charts and understand different trading theories. You've got a strategy and a set of rules to trade by. You've even got your money management plan mapped out. But have been to a psychiatrist yet? Ok, I'm partly kidding but really, have you thought about how you are going to handle the wild emotional swings of trading? I ask because trading can be a roller coaster: you'll feel the highest of highs and the lowest of lows, often in the same week or even the same day! I've felt a range of emotions through trading. One thing I've felt is the need to try and make up for losses as quickly as possible. I don't want to feel down for long, so why don't I just double down right quick and make up those losses really quick. Good idea? I think not.
So what do you do when you experience drawdown?
About six months into my trading career, I would stick with a strategy until it started to lose. Then I’d go on to the next strategy or trade idea. Sometimes this worked. Oftentimes it did not. So I needed to learn how to test strategies through backtests and live trading with small accounts to start. This way I could better know the types of swings that I may experience in the future. Understanding the intricacies of your strategy and how it behaves in different market cycles is essential. Then implementing the proper money management to ensure that we can withstand those drawdowns at our individualized risk tolerance levels. So going forward I know that I could safely stick my strategies and see the drawdown through because I don’t let emotions control my actions.
The idea behind a trading model is to gain an edge on the market. In technical based trading we, as traders, have to stop trying to predict what will happen next. Once traders start to try and predict where the market is going in the short term, generally it will affect the way we approach executing new positions, or the way we handle exiting existing positions. Traders that try and outsmart the market and don't stick to their strategy oftentimes will experience a "profit gap", where they never experience their profit potential. When trading in a drawdown, the trader has experienced negative trades resulting in low confidence in their trading system, and they feel betrayed by the market. Many times traders cannot recover drawdown because they have not accepted the risks inherent to trading. Trading while down, emotional discomfort and fear are present, which can affect the way we handle risk. Completely accepting the risk that we are assuming during trading, without the slightest bit of emotional discomfort is paramount to trading successfully long-term and recovering from drawdowns.
This is why picking a solid strategy that performs in different market cycles with a decent risk/reward ratio and using smart money management are keys to smart long term trading results.
As an investor the same principles can ring true. So trading through a drawdown can be tough, sometimes downright exhausting. But we have to stick with our core trading principles and trading plans so that we can come out on top and become profitable once again. A good trader should not be measured by profitable trades, but by how he/she handles the losing trades.