Sunday, November 08, 2015

Three Best Practices For Dealing With Trading Drawdowns

Perhaps the one most important takeaway from my recent book is to intensively study your successful trading, build a list of best practices unique to you, and then turn those best practices into ongoing habit patterns that, combined, become robust best processes. 

We can learn a great deal from the best practices of best traders.  One area that has struck me as especially valuable is the best practices of traders in the midst of drawdown.  Even the most successful traders encounter their periods of loss.  How they manage the losses--and how they manage themselves during the periods of loss--makes a huge difference in terms of their ability to come back.

Here are three best practices for dealing with drawdowns that I've observed among the most talented and successful traders I've personally worked with:

1)  Staying Constructive - Traders are often hardest on themselves just when they need to be picking themselves up.  They blame themselves for mistakes and undercut their own confidence.  When we first met Flora (shown above), she was an abandoned cat walking the neighborhood streets in New Jersey.  Some of the neighbors were helpful, and Flora quickly figured out who to go to for a little food and shelter.  She remained a homeless cat, but found a way to get by each day until we came along to adopt her.  Staying constructive means that you double down on the search for ideas and activities that will sustain you during the lean times.  One trader I work with was finding longer-term opportunities to be scarce, but found a way to successfully trade shorter-term patterns.  Like Flora, he's kept himself afloat during the worst times and positioned himself for success as opportunities appear.  The key is being able to become your own best support when times are tough.

2)  Stepping Back - For the best traders, losses provide information.  Maybe you're not seeing markets well; maybe markets are changing; maybe you're not trading well despite seeing opportunity.  When normal losses become drawdowns, something is amiss.  The answer is not, per the saying, redoubling your effort once you've lost sight of your aim.  Rather, stepping back from trading and engaging in careful assessment--assessment of you, assessment of your trading, assessment of markets--is a very helpful course of action.  Very often when good traders step back from markets, they return with new energy and new perspective.  That's in part because they've used the time to renew themselves, as well as their views.  Opportunity sets wax and wane.  A complete trading plan should map out your goals and activities for when you're *not* trading.  Without such a plan, you're more likely to overtrade--and extend the drawdown.

3)  Connecting - One thing I've learned from those who have sustained long-term success is the importance of solid personal, romantic, and spiritual connections.  If you're truly diversified in your life's activities, there will always be something paying you off even as the trading area is lean.  By connecting to the people and activities that are most meaningful, you make it easier to step back and stay constructive.  Think of your life as a diversified investment fund.  You are invested in different people, different values, different organizations, different activities.  The sum of those investments provides a relatively smooth upward emotional P/L curve.  Like any good asset manager, you're going to rebalance your life's portfolio at times.  Drawdowns in trading are often a great time to achieve that rebalancing.

Ultimately, the key question is whether we emerge from drawdown stronger or impaired.  If life is a gym, challenges are there to make us stronger.  That is why risk management is perhaps the best trading practice of all.  Without sound management of risk, we can take ourselves out of the game before we have an opportunity to learn from adversity.  As Flora has demonstrated, great things can happen if you can manage to stay in the game and persist in finding answers.

Further Reading:  Handling the Adversities of Trading