Into the Abyss and Back: Lessons from Our Ultimate Drawdown

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    “Success consists in going from failure to failure without losing enthusiasm” – Winston Churchill

    All traders want is to not lose. I don’t think any trader wakes up in the morning expecting a loss. However, loss is just part of the trade (and life) and the fear of loss is the path to the “Dark Side” (as Master Yoda put it).

    Ray Dalio is credited with creating a culture at Bridgewater that values ​​failure: it’s often through failure that we can learn something. So, in this final article of 2017, let’s share what we learned during our biggest failure to date: our period of maximum drawdown.

    Performance vs. profitability

    The first lesson is a reminder quality trumps quantity at every step. By trading less, we’ve actually gotten better returns lately. As an extreme example, from December 1st to December 15th, we only made 2 trades with our Model London Openfinishing with a positive 0.5%.

    On the contrary, before and during our period of decline, we were much more active and a little less selective in our fights. The message is clear: it is possible to achieve better results with less activity. Said better: do not force trade.

    Many traders believe that they need to be active every day. Many traders will be sitting in front of their screens “hunting” for trades. At some point, we also fell into this trap. But we learned the lesson very well: profitability does not require much activity at all. Don’t try to “hunt” for deals, but instead wait for them to “pop out like sore thumbs.” Risk your capital only on the most obvious scenarios of your trading model.

    This is one of the reasons why we sought to develop alternative models in 2017 and came out with End of day signals and Newsflow signals. By having multiple models to work with, we can be more patient with each individual model and only look for the best situations for it. In this way we can maintain a decent level of activity without the risk of reduced profitability.

    Trade Management vs Trade Selection

    The second obvious lesson is related to trade management. As we noted earlier, trade management is not a panacea.

    In the chart above, the burgundy line represents our actual equity curve for short and intraday trades made during the drawdown period. Here’s how we modeled the other equity curves:

    • The green and yellow lines try to stay in the market while the momentum continues, using a Supertrend as trailing stop. They also close 50% of the position when 1R is reached.
    • The blue and orange lines try to do the same, but remain fully invested and either hit their profit targets or are stopped out with a trailing stop. This is a slightly more aggressive driving model.

    The main lesson is this Trade management alone cannot turn things around. This can dramatically worsen the situation, but it cannot turn a series of bad trades into a good equity curve.

    Conversely, in the chart above, we have collected swing trades (multi-day in nature) made during the same period. The initial equity curve itself is not enviable, but it is not a disaster. However, using the same trade management simulation as above, the results could be significantly improved.

    What we learned is simple but effective: trade selection really knowing what the best conditions are for your pattern is what helps keep losing streaks short and drawdowns large and long.

    This begs the question: How do we pick the “good deals”? Is it possible to select only “good deals”? The answer is of course yes, good trades can be picked, but what constitutes a good trade depends on your trading model.

    In ours Forex system development seminar, we try to help traders understand the principles on which they build their systems. If you know what your model needs to do, you’ll also know how to make it easier.

    Trade from the drawdown

    Finally, let’s address what we did right during our down period. Maybe that’s the one thing that kept us alive: the size of our position. When we noticed a drop in performance, we immediately reduced the position size to 1/4 of the normal size. This precaution allowed us to gradually analyze and adjust our model.

    The lesson is actually twofold:

    • you should always be able to determine whether your trading model is meeting expectations or not;
    • you should reduce risk when the results start to deviate from the previous course.

    Since your position sizing model depends on the quality of your system, if the system is performing well, you can move towards your goals; but if you notice a drop in performance, your position size should help you preserve your capital.

    To you

    2017 was indeed a busy year for us as we simultaneously had to contain the damage that our decline could have caused, learn the lessons and make the necessary changes. We did not discover anything new or innovative. We’ve verified on our own data what Market Wizards have been telling us for nearly 40 years.

    Sometimes the only way to truly learn a lesson is to make a mistake yourself and find a way out of it. We hope you found our mistakes interesting and instructive. We got out of our difficulties with 3 trading models, an reinforced educational section and many other experiences to share.

    2018 here we come…

    About the author

    Justin is a Forex trader and coach. He is a co-owner www.fxrenew.comprovider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to Advanced Forex Course for Smart Traders. If you like his writing, you can sign up for the newsletter for free.

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