Lets talk trading drawdown. Yes, that nasty occurrence that traders everywhere love to hate. Drawdown equates to the sky crashing down on top of your portfolio and leaving you questioning every trading decision you’ve ever made. But wait please, before altering what could be an excellent trading
system you’ve spent countless days and hours on lets think about what can be done. To round out our thought process, first have a look at a by the book definition of trading drawdown from Investopedia.
Now, understand that drawdown is going to happen. It happens to everyone and for some it happens often. In fact, as I write this post I’m experiencing some drawdown in my personal accounts as the market fights through some serious global headwinds. As I write, Italy is thinking about abandoning the Eurozone, trade wars are escalating, Saudi is shaking the oil markets, and we can’t forget the unending series of political snafu’s derailing the market at every turn. However, as bad as that sounds its just business as usual. We must accept, there will always be some global crisis or untimely misstep destined to drag the markets one way or another. It’s how we as traders handle the fortunate and, in this case, unfortunate series of events that leads to account growth.
What to do about trading drawdown?
Now, lets take a few minutes to identify what can be done when drawdown comes knocking. Below are the only 3 steps you need to know to avoid, sidestep, or overcome account drawdown.
- Don’t panic!
- Adopt and Adjust.
Let’s discuss each, in order.
1. Don’t Panic!
This cannot be overstated. All to often traders panic and start closing positions while consequently accepting a larger loss than would have occurred if they had done nothing at all. I know because I still struggle with this myself. To watch as days or weeks of profits evaporates and turns south isn’t easy. In fact, its down right painful and as humans we’re programmed to try to do something to soothe the pain. Unfortunately, that soothing comes generally in the form of escape. You know, that ol’ fight or flight response at work.
My suggestion, for whatever its worth is to stop and think. Refer to your trading plan for the reason why you initiated the trade in the first place. Your assessment may still be valid in the longer term, regardless what’s happening today. If you believe it is, great, there is nothing else to do but ride the wave. If your opinion has changed, that’s great also, just continue to step 2 and 3 below.
(If even possible given the emotional turmoil experienced from watching your account drown a slow agonizing death.)
We must however, complete this step. Leave emotion at the door and reassess your current portfolio. Look at why you entered the existing trades, look for reasons that decision may have changed, and finally look for solutions(if needed) to the current problem. For example, can you change a long put into a short or long vertical, can that put be incorporated into an iron condor, and the list goes on. The idea is to start thinking about ways to save the money you’ve already invested, even if that means adding to or changing the position altogether and that leads us to step 3, making the change.
3. Making the change. Adopt and adjust.
Once you’ve curbed your emotional and psychological state, really, step 2 and 3 are just normal operating procedure. You’ve re-assessed the situation and accepted that trading drawdown is just the current monkey on your back, thus allowing you to get on with altering your portfolio. Now, I should also state that at this juncture not altering the portfolio is a viable option, or at least not altering all of it. Please remember, sometimes the best change is just patience. As difficult as that can be.
In any case, you’ve made the decisions adjust, implement them and adjust your time horizon’s accordingly and your all set to weather the current storm back to a profitable state.
No one said trading was easy, did they? If you have any questions ask me in the comments below.
May God bless and keep your trading profitable,
Jeff the “OptionBoxer”