Work harder, trade fewer in a long and excruciating trading drawdown

I write this as I am in my [first trading drawdown of 2010][]. As I said [previously][first trading drawdown of 2010], I find that I am still ill-trained to respond to big drawdowns. I caught myself over trading again hoping to rake in a few quick paper bucks in my demo account to get myself out. However, the ability to maintain discipline and performance under stress is what separate the pros from newbies like me. I know what I must do at the back of my head but I took the easy way. This trading drawdown is definitely bringing the worst trader in me. As Dr. Steenbarger wrote in his post on [Stress and Performance in Trading][], > "... one reason stress might affect performance among traders is by > skewing their assessments of risk and reward. Under pressure, traders > may narrow their cognitive scope to only the information most salient > to them (availability bias) or relevant to their expectations > (confirmation bias); focus only on superficial qualities of > observations (representativeness heuristic); or become more likely to > take profits than losses (disposition effect). In other words, stress > disrupts performance by altering normal, sound information > processing." In addition to a narrowed mindset, the cause of my bad habit to over trade during a big drawdown is that I subconciously associate the need to recover my account balance with the need to trade. Nothing will happen if you don't trade, right? Well, at least you won't lose anymore than you have. That would have been a good start. So I considered to ease back on trading by focusing on [my quant work][]. Then I realized this is yet another misconception. I was merely walking away from my problem. What I needed to do is to face it, not with mindless trading though. **During a stressful drawdown, work harder and think plenty about the market, *not* about recovering from your drawdown**. In the mean time, only trade your best strategy to reap the best probability of profits. At the end of the day, nobody can dig yourself out of an account drawdown but you. Something must have been wrong with your trading or your current perception of the market to get you in a drawdown. Or, it could very well be just plain old bad luck. In any case, take a step back from trading and use the opportunity to realign yourself with the market or wait for market conditions to sync back with you. This is a forgotten lesson that I have wrote about in a [previous drawdown][]. I have since added an additional section in my [trading rules][] to impose it upon myself with this re-ocurring problem. I can never get rid of large drawdowns completely because they are a regular part of trading. This particular one has been a great self-discovering experience. Ultimately, learning to cope with trading under stress is one of my top training priorities to achieve before moving on to trading a live account with real money.

First 2010 trading drawdown analysis on the verge of a new record

I am close to passing my biggest monthly drawdown ever in my forex paper trading endeavour. My account drawdown is at -3.34% now. My record was set in last November at -3.44%. And it's only the 13th! To make matters worse, this isn't one of those transient, surprise drawdown. It is a slow and steady one. An excruciating one. See Figure 1 for my account balance graph for this month so far. Feel my pain! My post earlier this month on [10 questions to ask yourself if you are holding a ginormous losing position and don’t know what to do][] was a real harbinger. I wrote that piece at precisely the top point on Figure 1. If only I can time my trades that well! But instead of a single ginormous losing position, I am faced with losing trades one after another. Thus, drastic measures need to be taken before I mark a new drawdown record. This post is a self-assessment on what I've done wrong and my plan to turn this wreck around. [caption id="" align="aligncenter" width="580" caption="January 13 account balance"][][][/caption] Upon review of my trade log, it is apparent that my account suffered because I was too eager in shorting the Aussie. As a standard risk management procedure, I kick started my emergency protocol when my drawdown reached 3.00% last week as I tweeted. Basically just reducing my risk by trading with only half the usual position size. That was all last week. This week, I found myself breaking another of my trading rules. I am letting this drawdown affect my trading, in a bad way. Specifically, I am letting my need to perform affect me by starting to day trade the GBPJPY currency pair! If you might recall from last year, I resorted to the same desperate measure (isn't it great to be able to recall my past trading experience just like that?) and that was the month when I had the largest drawdown. Exactly because of that. In fact, the drawdown emergency rules posted last time are as appropriate as ever. Heck, I will copy and paste these rules in my 3 rules of trading as a permanent fixture. I seem to need them quite often. I can't helped but feel chagrined with the fact that my current situation yields itself to a perfect follow-up to my previous post on trading drawdown. However, this is what it is. In my next post, I will examine why I keep going back to this same bad habit of day trading (even though I suck at it) when I am under pressure.

[10 questions to ask yourself if you are holding a ginormous losing position and don’t know what to do]:

10 questions to ask yourself if you are holding a ginormous losing position and don't know what to do

In the unfortunate case that you are holding a massive losing position in your portfolio and don't know what to do, the first step to fight back is to reassess the situation with a rational, unbiased mind. Easier said than done. But that is what I learned the hard way a few years back when I bankrupted my trading account in a single stock. I waited for weeks and then months. While checking online forums for discussions on the stock, eager for others to fuel my hope. Hopes for the stock to come back to some better price so that I can unload. 3 years later, the company's stock price is still screeching along the zero mark. While I'd like to think that I have come a long way since then, there is no guarantee that I won't find myself in that situation again. As such, I developed a self-assessment questionnaire with questions that needed to be asked in a crisis. But often not because people are always too emotionally caught up. It is like an emergency checklist for the emergency. Here are my 10 questions to ask yourself when nothing is left but false hope in a dire trading position:

  1. What is your current account drawdown compared to your previous performance?
  2. How proven is your trading system?
  3. Are your reasons for entering this position still valid?
  4. Is the reason for letting the trade breakaway from you within your trading strategy?
  5. What are the emotional reasons to hold this trade?
  6. What are the logical reasons to hold this trade?
  7. What are the emotional reasons to exit this trade?
  8. What are the logical reasons to exit this trade?
  9. What can you do to reduce your overall risk?
  10. And last but not least, WHAT IF the price breaks against your trade even further?

In any case, once the crisis is over, it is time to reflect and review what went wrong to prevent this from happening again. After all, at least make something out of this by learning and improving. And if you can, please share with us your learning experience in the comments below to help other readers.

“There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!� Reminiscences of a Stock Operator, by Edwin Lefèvre

An example of how trading in fear is bad for your account

Having had a hard time day trading the EUR/USD last week, things haven't been well for me this week either with the market in a gridlock. My one and only viable setup so far is built for a trending market. So this range-bound market is new territory for me as I experiment (in hindsight, haphazardly) to come up with more profitable forex trading setups. As you can imagine, trading without discipline is a recipe for diaster. I have given back all the paper gain from this month by the start of this week and is treading on thin ice with my demo account dipping dangerously close to the November opening balance. Needless to say, I do not want to see my account in the red for this month. But that is what happened after today's string of failed trades. I am officially in the red for this month, for now. While there are several mistakes I made resulting in this mess, I think it all boils down to one flaw in my trading this week. Yes, those day trading stints I did surely have put a dent in my demo account, but what's worse is that I've unconsciously have let those losses affect my trading mentality. These losses were stuck in my mind and my mental "goal" for this week was recovering from them. However, I have approached the problem in the wrong way by not wanting to lose anymore in my account. In other words, I was afraid of losing. So how did that materially affect my trading? Here is a simple example as illustrated in my order history on the GBP/JPY chart attached at the bottom of this post. The 3 yellow triangles are my short entries and the 3 red dots marks the stopped exits. According to my setup, my original entry at 149.50 had a stop at 150.50. But I moved my stop closer to 149.80 in the morning because I didn't want to risk more. That got taken out easily as 149.80 is within the congestion zone. Then I tried to short it a couple more times with tight stops because I see the downside potential to be still intact. Those were eaten up alive too and now I don't have a position because it would have been more foolish to keep trying in vain. While just 3 trades wouldn't have done much damage, I was doing the same thing across the board in shorting CAD/JPY and EUR/CAD. A few here and a few there. They add up to a bad day. As of this writing, it looks like these pairs are finally moving in my direction. But instead of being patient with reasonable stops, I thought I could do better and micro-managed my positions to end up taking multiple small losses and with nothing left on the table to ride the move. So what is the correct way of following up on a dent in the account? I should have done the following instead:

  1. Reduce risk exposure by limiting trade size or overall opened positions until I am back up.
  2. Focus on what I did wrong last week and stop doing that, i.e. no more day trading.
  3. Recall my best trades and do more of that, i.e. my one and only finalized setup, FTC.

Not so coincidentally, now that I'm in the deepest drawdown ever, this is as good as ever to put this emergency recovery procedure into practice.

[caption id="" align="aligncenter" width="580" caption="GBP/JPY, 1-hour"][GBP/JPY, 1-hour]GBP/JPY, 1-hour[/caption]

Posted 18 November 2009 in forex.