When You’re in a Drawdown
Instagram traders will make you believe that once you figure out how to make money trading, you’re on the easy street to all your dreams.
However, real-life day trading, even when you have achieved success in trading, is far from easy. The pressure of maintaining the income for your lifestyle, be it a house, toys (cars, bikes), holidays, or private school fees, amplifies every time you’re in a drawdown. Panic sets in that this is it - you've had it. You will lose all these privileges and will never be a profitable trader again.
The first thing to understand is that this is absolutely normal. Every single pro trader goes through drawdowns and periods of low confidence. What separates full-time traders from the rest of the 99% who tried and failed are the actions they take and how quickly they can recognise they have a problem. The reason only about 1% of traders make a full-time income from trading is largely due to the misconception that once they have “cracked the code” and are profitable, that's it; they're on easy street for the rest of their lives. But in reality, this is where the real work starts, and maintaining this profitability is extremely difficult due to the pressures and doubts that traders face every time they are in a drawdown.
So, What to Do When You're in a Prolonged Drawdown?
The first thing to recognise is what not to do. Do not ignore it and keep trading as if nothing has happened. While it’s normal to have drawdowns, as a self-guided trader, you must realise that you’re going in the wrong direction as soon as possible. This is typically obvious when you've had a few unexpected losing days in a row, when trades that were sure winners didn't pan out, or when you haven’t been making money for more than a month.
For funded traders, this recognition must come BEFORE they hit the maximum loss limit imposed by the funding platforms. For example, if your maximum drawdown limit is 10% then if you experience a drawdown greater than 5% you would follow the steps below.
For self-funded traders, this ratio can be the same so if you’re expecting a maximum drawdown of 30% from your trading strategy once you experience a drawdown greater than 15% then you would do the steps below.
STEP 1 - STOP TRADING!
When you recognise that you’re going wrong, the first step is to STOP trading, no questions asked. You can’t make it better only worse. Remember that your ego will want to keep trading and recover the losses ASAP, telling you things like - you'll miss a big move on this trade or this day, etc. This is nonsense. The market will always be there. When lack of confidence is matched by an increase in pressure you can’t make good decisions under pressure. You need to take a break until the pressure drops and the panic from thinking, that's it, I had it, is over. To get out of a drawdown, you must be at your best and in a neutral, objective state. The only way to return to this state is to STOP trading.
How long should you stop trading? It depends on each situation and your state of mind, among other factors. It can range from a few days to several months. Generally, I recommend taking at least one week off. I've even taken 4 full months off when I could see I was just digging a bigger hole for myself. So, the deeper the hole, the longer you will need to climb out of it. However, at least 4-5 days are essential to flush out the negative hormones and emotions from your system before you can think objectively again.
STEP 2 - REVIEW!
Next, check to see what’s gone wrong. You need to pinpoint the problem.
1) Review Your Trades
You should journal all the trades you've made and review them one by one. I prefer to actually print out the charts for this process. Mark your entries and exits and go through the trades bar by bar. When reviewing your trades, ask specific questions:
Did I enter as per my rules?
Did I enter too late?
Did I enter too early?
Did I force trades?
Was my Stop Loss correct?
Was my exit as per my rules?
Did I exit too early or too late?
Did I manage the position as per my rules?
Was I too greedy?
2) Review Your Trading Diary
If you've identified an issue, ask yourself, "WHY DO I HAVE THIS ISSUE?"
If you keep a trading diary, go over the days you performed poorly and look for clues about your mindset. If you don’t have a diary, I highly recommend starting one, especially for situations when you need to reflect on your state of mind during the trading process a few weeks or months ago. Were you tired or stressed? Did you argue with your spouse or children? Was your health compromised? Did you rush to get ready for the trading session? These insights can explain why you faced certain issues.
Then ask “HOW CAN I FIX THIS ISSUE?” It could be that you are overtrading, neglecting your health or risking too much. If you have multiple issues it is important to focus on one major issue at a time. You can not fix all issues at once so pick the most pressing issue and the one that cost you the most money and fix it, then move on to the next one.
3) Backtest Your Trading Strategy/Rules on a larger data set
It's entirely possible that you followed your strategy to the letter, but unfortunately, your method underperformed in current market conditions. Markets constantly change, shifting between trending, ranging, high volatility, low volatility, and seasonal patterns. This change in the market has exposed a weakness in your trading strategy/rules. Thus, you need to backtest your strategy across a range of market scenarios and on a large data set of a few years at a minimum. This process will either boost your confidence to return to trading or signal that it's time to adjust your trading strategy rules. Trading is always about adaptation. Full-time traders recognise this and continuously learn and refine their approach.
STEP 3 - Restart Trading with a Reduced Size
Once you've completed Step 2 and feel ready to return to trading with confidence and objectivity, it's time to start again. However, you should trade at a significantly reduced size compared to before, ideally half or even as little as 10% of your original size. Restarting isn't about making money; it's about regaining confidence in your trading abilities. Trading hinges on confidence. By demonstrating that you can STOP, REVIEW, and then restart positively, you'll build that confidence. Then, you can gradually return to your original size, equipped with a blueprint for successfully navigating drawdowns, ensuring a successful full-time trading career.
Trading is always about adaptation. It's a dance of one step back, and two steps forward. The challenge for full-time traders is to recognise when you need to take that step back, allowing you to pause, review, and restart without losing too much ground.
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