Coping with Drawdowns in Futures Trading

Coping with Drawdowns in Futures Trading

 

 

Drawdowns are among the most difficult things for futures traders to cope with. In fact, they are the primary reason that many traders quit trading. The reasons for this are usually psychological and must be understood if traders expect to be able to continue trading successfully over the long term. Drawdown is simply the amount of loss between equity peaks over a set period of time. I’ve heard, though I don’t remember where, that drawdowns are like exhaling – necessary and natural. One cannot go on inhaling indefinitely, the ups must be punctuated by downs, though ideally of a lesser magnitude.

Viewing drawdowns in a new light

Drawdowns must be viewed within a larger framework. One reason that drawdowns affect traders so acutely is because they aren’t viewing their trading in it’s entirety – over a long period of time. Many futures traders tend to focus on trades singly instead of seeing them as part of a “pool of trades” executed over an extended period of time. This mindset causes losses to be felt more deeply, as opposed to the mindset that see losses as small instances in the grand scheme of things. In the former mindset our emotions and psyche will be dictated on the success or failure of individual trades. So, if they profited on a particular trade they’re happy and if they lost on a trade they’re upset.

It’s important to understand how these emotions color our trading behavior. Becoming too elated over the success of any one trade often leads to a feeling of invincibility and wrecklessness. This is a very dangerous state to be in, as it easily causes sloppy trading decisions and the taking on of unacceptable levels of risk, which can result in large losses. Conversely, dejection over failed trades can lead us towards desperation and anxiety, which often results in poor trading decisions based upon a need to validate our feeling of personal competence.

The latter feeling is also counterproductive because it has a tendency to make us question our trading methodology. We may ask ourselves “Maybe my system is flawed”, or “I was following all of my rules with discipline, why hasn’t it worked?”. Most of the time, if you’ve done your planning and stuck to your trading plan with discipline, it’s not your particular trading methodology that is flawed. The simple fact is that every method will have a certain percentage of drawdown. Sometimes those losses come one after another in a seemingly endless fashion. But, nine times out of ten, the upswing is usually just around the corner, if only the trader will have the courage to persevere through the losing streak. Sadly, it is during these losing streaks that many traders decide to hang it up and abandon futures trading altogether. As stated above, traders should focus on profiting over the long run, instead of trying to enrich themselves on individual trades.

Stick to a trading plan that accounts for the inevitability of drawdowns

The only way to survive these drawdown periods is by following your risk management plan methodically. Remember that whatever trading system or methodology is used, your risk management plan is supposed to take into account its estimated drawdowns. So, by managing your capital properly, the trader will be able to weather the drawdown periods without risking significant erasure of it. Please note that risk management will not eliminate drawdowns, but rather seeks to make drawdowns manageable so that trading capital can be preserved over the long term.

However, devising and incorporating sound risk management principles into your overall trading plan is the easy part. The other, more difficult component however, is having the courage, discipline, and confidence to see it through. This can be extremely hard to do in the face of extended drawdowns, regardless of the fact that you estimated and allowed for these losses. Yet, this is exactly the psychological task that futures traders need to focus on – conquering the defeatism and mental delusions that occur inside the mind when drawdown periods are in full swing. Learn to cope with the psychological hurdles of drawdown syndrome and your futures trading will fare well in the long run.

Learn to Trade with Confidence

It’s an all too common occurrence. A trader has used his trade selection process to pick a seemingly profitable futures contract. Using his favorite analysis methods and indicators he has narrowed his search from a group of possibilities to a worthy candidate. A trading plan has been developed, specifying entry and exit points along with profit and loss objectives. All seems ready to go. Then, he begins reading the daily market reports and trading recommendations regarding his chosen commodity that have been written by supposed experts. Many of them make predictions that are very different from his own. The trader now begins to second guess himself and vacillation sets in. What is he to do? How can he take a position that is opposite from what the experts recommend?

View expert opinions with a grain of salt

This sort of thing occurs in the minds of thousands of traders every day. Those that fall prey to it often take no action and miss out on profitable opportunities. Still others, who lack faith in their own abilities, will alter their trading decision and follow the advice of market “gurus” and “experts”, often to their disappointment. The successful trader needs to develop confidence in his own ability to analyze the market and choose viable trades. Confidence is the key word here. It is an unmistakable attribute of all successful futures traders. One must learn to silence much of the incessant chatter about the market that goes on every day. If you don’t, it will lead to inaction or incorrect action most of the time.

 

Now, I don’t suggest you simply ignore the market commentary of others. It is alright to take other opinions into account. At least for the reason that they can make you reassess and go over your trading plan to make sure you haven’t made any blatant errors in judgment. My advice is to ‘listen’ to a few chosen voices, but don’t let them ‘dictate’ how you will act. One must remember that many of the opinions of “experts” are often proven to be wrong. In addition, many of those who write market commentary and make recommendations do so for a wide array of commodities on a daily basis. This is an overwhelming task and it is often the case that they have not delved into the particulars of your chosen commodity as deeply as you have. Typically, they rely on a couple of indicators to make their judgments. These indicators may not be the same that you use, nor may their assessment be based on a level or risk that is acceptable to you. In short, their criteria for judging trades is often vastly different than your own. This is especially important to remember if your basket of tools used in forming a trading plan has given you good results in the past.

 

 

Learn to trust yourself

 

Trust your plan and trust your powers of judgment. Furthermore, keep this sense of confidence in yourself throughout the duration of your position in the market. Loosing confidence in yourself and your trading plan while holding a market position most often results in losses. If doubt is haunting you and you cannot control, it is best to simply offset your position and be clear of the market. Reversing or altering your trading plan in mid-trade is the last thing you should do.

 

The most important thing to remember about trading with confidence is this: No matter how diligent or thorough your research into a particular trade, you may still end up wrong about the direction of the market. This is true for everyone, nobody is right every time. You might be wrong this time, but your trading plan (with clearly defined loss thresholds) will save you. So, in the final analysis, it isn’t always being right about the direction of the market that will make you a success. Instead, it is having the discipline to stick to your trading plan that will.