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How to Win at Losing: Four Steps for Dealing with Drawdowns

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October 1, 2012
coach corner losses drawdowns
Fredrik Broden

At some point in your trading career, you may experience the jolt of a fairly large drawdown in your equity curve—either through a string of losses, or one big one. Either way, this is every trader's cross to bear. So how you cope with the situation may not only define the depth of the loss, but also your ability to recover.

Get Over It

As a trader, drawdowns are a fact of life. Just as the market moves up and down, so goes your trading account. Feelings of regret from a large loss can beget further errors in judgment, such as rationalizing why you should continue to hold losing positions. Research by the Econometric Society shows that the second $100 loss is easier to take than the first. And the third is easier than the second—until, at some point, the trade becomes a “buy and hold” investment regardless of your original strategy.

Shine Your Dancing Shoes

Avoiding drawdowns is impossible. However, the negative effects both financially and psychologically can be mitigated. How?

1/Visualize. Have a vision of what you're trying to accomplish over the next one-to-five years. Then define a plan for what you need your trading account to do on a weekly and monthly basis to make that happen. Having a long-term goal, and then managing positions in alignment with those goals, will keep you less myopic and more focused on the prize.

2/Size your positions smartly. Too much size and a sudden, adverse event, can be devastating. Too little size, and a favorable market barely moves the needle. Figure out the position size and risk that works for your profit/loss, and stick with that.

3/Get out. There's no shame in shedding your losers. Don't let ego, hopes, or fears paralyze you. As the old saying goes, “Sell down to the sleeping level.”

4/Get back in (when you're ready). After a large drawdown, you may be afraid to get back on the dance floor. That's fine. Perhaps you paper trade using something like paperMoney® on the thinkorswim® trading platform until you're ready to put real dollars back to work. When you put on a smaller portion of the positions than you normally would. The first goal isn't to get back what you lost. And, trade the amount of positions typical for you, but keep the size small until you build confidence.

Drawdowns happen. But so do profits. Accepting that things change is crucial. So after a drawdown, move on. I like to say I've given up all hope of having a better past. So, remember the lessons from the past, look to what you can do now, and build towards your future.

Funny Money

Getting back in the game is easier said than done when committing real trading dollars. With paperMoney, you can work on building your confidence back with a fake money/real market experience. Just pull up the log-in screen on thinkorswim, and select paperMoney before signing in.