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.