A string of losses stinks, but there’s hope. Learn four steps for mitigating the impact of drawdowns, and how to get back in the trading game.
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.
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.
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.
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.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Investools® does not provide financial advice and is not in the business of transacting trades. Investools, Inc., and TD Ameritrade, Inc., are separate but affiliated companies that are not responsible for each other's services or policies. PaperMoney® is for educational purposes only. Successful virtual trading during one time period does not guarantee successful investing of actual funds during a later time period as market conditions change continuously.
Neither Investools® nor its educational subsidiaries nor any of their respective officers, personnel, representatives, agents or independent contractors are, in such capacities, licensed financial advisors, registered investment advisors or registered broker/dealers. Neither Investools® nor such educational subsidiaries provide investment or financial advice or make investment recommendations, nor are they in the business of transacting trades, nor do they direct client futures accounts nor give futures trading advice tailored to any particular client’s situation. Nothing contained in this communication constitutes a solicitation, recommendation, promotion, endorsement or offer by Investools or others described herein, of any particular security, transaction, or investment. Investools Inc. and TD Ameritrade, Inc. are separate but affiliated companies that are not responsible for each other’s services or policies.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.