How do you handle a huge drawdown?

Discussions about personal psychology for the individual trader.
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Roundtable Knight
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How do you handle a huge drawdown?

Post by NeueZiel » Fri Sep 12, 2003 9:58 pm

I am sure this was asked before. Personally and philosophically speaking, it is not how hard we fall but how fast we get back up. Many traders have hit their lowest low whereby it will make one reconsider things.

So... how do you guys handle it? Do you cut back your trading or take some time off from trading all together and pursue some self reflection and/or comtemplative instropection?

As for me, I have hit my first real drawdown whereby losing 15% of my equity yet I still know that my system is still in working order. Having a balance lifestyle is very important especially as being a lone trader. Outside activities for me personally have helped me to re-energize and reinvigorate my passion. So... I have stopped trading for the past three weeks and gone fishing everyday or drove up to Orlando and got on some rollercoasters. I may need around three months of mental and physical relaxation before I jump back into the game. And not to forget meeting some old college friends and hit the slopes in Vermont for some major fresh powder snowboarding.

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Post by damian » Sat Sep 13, 2003 1:41 am

:) How do I handle a huge draw down? More to the point, I do I define a huge draw down. I will swap mine for your 15%.

I am actually spending my time in DD exploring how it is influencing me as human operating a trading system.

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Post by Kiwi » Sat Sep 13, 2003 2:16 am

I too laughed a little at the definition of 15% as huge. When I first went through 15% I had it under control. This was still 10% off what I expected to experience. At 30% I thought I was losing control. Fear and self doubt were present in big quantities. Prayer was much on my mind :shock:

When I went thru 30% and realised how much I was down in dollars I really got a lesson in my tolerance for risk. So what did I do:

- I reviewed my historic data and the old equity curves which told me that this was not only possible but had happened more than once in the past. It also told me that the rise out of it might be followed by another fall after only a brief period in equity highs.

- I reviewed system performance against theoretical for the same period. Not to bad. I reviewed the systems themselves to make sure that the principles by which they mined gold had not changed in any fundamental way.

- I worked on being philosophical about it. I decided to only check my equity once a week, recalling that there is more pain in a down tick than pleasure in an up tick and that they happen in similar numbers.

- I did more exercise and meditation to avoid ulcer meditation.

- I considered getting a job again and put plans in place just in case I had to do it. Fortunately it didn’t happen :-)

Very importantly I diversified my systems to include some weekly earners that help me be philosophical about dips in my long term systems.

So, now when there is a drawdown I feel pretty relaxed about it. I often wish that George would settle for the pain of Iraq and not keep scrapping with the other kids so that we again get some gentler macro trends. But I am diversified enough that I'll continue trading whatever he does. I just focus on executing my plan as well as possible.

I never stopped trading the systems but perhaps that is the nature of the systems I operate. I will take holidays from my short term systems so I can understand the choice you are making. If your system was long term though I would be worried that you might do what many fund investors do - jump just before the systems recover.


Roundtable Knight
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Post by NeueZiel » Sat Sep 13, 2003 6:13 am

Wow. You can handle a 30% drawdown eh? Good for you. Loss and profit is all relative anyways. Personally speaking I don't think I can handle that amount of a drawdown. A loss of 12% to 18% to me is excessive so I tailor my systems to fit my aversion for big losses. I would rather take a smaller profit than take a bigger loss. I don't like to lose sleep at night or begin worrying and start losing mental control and having self doubts. That is just me.

Mark Johnson
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Post by Mark Johnson » Sat Sep 13, 2003 9:05 am

The most popular mechanical trading system of all time is BUY AND HOLD. It's vigorously promoted by authors, TV talking heads, and Nobel Prize winning economists. Millions of people use the system for their trading, especially in their IRA and 401(k) accounts.

Buy and hold has large drawdowns. Those who champion the system say "don't change a thing, stick to the system and you'll be fine. Pay no attention to drawdowns."

In the last 3 years, an investor who used the Buy and Hold system on the Dow Jones 30, suffered a 31.1% drawdown. Those who bought and held the S&P 500 suffered a 49.1% drawdown. And those who bought and held the Nasdaq Composite Index (home of Cisco, Intel, et al) suffered a drawdown of 77.9%.

Turtle, Aberration, I-Master, Golden-SX, Oddball, and Onyx traders aren't the only ones who're living through a painful drawdown. :P

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To kiwi

Post by henryluk » Sat Sep 13, 2003 9:27 am

Just want to ask kiwi more about how you trade different systems to diversify enough so that you can psychologically cope with drawdown more easily? I think I really need to learn more in this area.

you talked about "weekly earners". do you have intraday systems that are able to return profit weekly?

do you trade say equal number of short term systems and/or medium term and/or long term systems? or a few ST then one medium term/one long term?

How do you spread equity around?

do you also diversify nature of systems? say short term volatility systems and medium and long term trend following?

Thank you for your help. :)


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Post by Sir G » Sat Sep 13, 2003 11:17 am

I recall reading in various places that Commodity Corp, Tudor Jones & Monroe Trout all incorporated trading stoppages at certain DD levels.

I know that you can read Monroe Trout discussing it in New Market Wizards.

There are actually 3 steps to this logic.
  1. The thresholds to stop trading
  2. The duration of the cool-off period
  3. How to re-enter the positions
Thresholds to stop trading
  • If you ever lose 4% of your account in any given day.
  • If you have a monthly loss of 9.9%
  • When a 30% DD is reached.
The duration of the cool-off period
  • The daily stoppage-Resume trading the following x days, or next Monday
  • Monthly Loss- Resume trading at the start of Next Month.
  • 30% DD – give yourself x days to cool off, say 1 day for each percent lost.. so in this case 30 days.
How to re-enter the positions
  • Do you take only new signals?
  • Do you enter all Open Positions, in a FIFO, First In-First Out fashion?
The benefits are many for something like this.
  • You go into trading, knowing you have some escape valves.. Trading is not to the death.
  • It removes you from environments that might do further damage.
  • It gets you out of the battle and you get your thoughts together.
  • It prevents you from receiving the full brunt of some of those outlier events that really can cause you damage.
The biggest risk is that your system makes a full recovery during your cool off time............. But the whole idea of this is not to exploit opportunity, but to control your risk. You need to survive these events so you can exploit opportunities in the future. Large DD’s can do damage to your account. As we all know the math of Peak to Through is different then the math of Through to Peak. And not to overlook is the emotional damage that can be caused during the DD.

The controlled stoppages like this are ways to nip a few problems in the bud. You never want things to get out of hand.

Do traders trade?????....... Not always.


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Post by Kiwi » Sat Sep 13, 2003 9:48 pm

Good points Gordon.

I would happily apply them to my short term strategies. I do have a very similar rule about what I must do if I make mistakes in any of my operations.

If I am happy that the long term system is still valid then I've seen too many historical (both back test and in my trading) situations when the recovery comes out of the pain. I remember trading GSX on crude oil and stopping after 3 losses in a row ... crude had clearly gone bad and I moved the equity to something else ... only to see a two large winners in a row following that. More training in being stoical.

It was funny to see Mark's list of systems in a drawdown. Most of the systems listed have been in large drawdowns recently but GSX made a new equity high a couple of weeks back (on the specific portfolio I use it for) showing the value of a slightly different entry/exit rule set.

Henry, I will try to answer the questions:

"weekly earners" I trade two short term strategies. One is a counter trend 1/2 hour index system that should not have drawdowns in excess of about 6 weeks in fact hasn’t had one in excess of 3 weeks over the last 6 months. I run this on a spreadsheet. I am also trading 3 minute bars on Eurostoxx50 and Bund - although depending on your time zones this could be the SP and TBond. I do this in a discretionary manner using Woodie's rules and have only recently moved from paper trading it to cash. I do it for two reasons, first because I needed to attend to the market for the countertrend systems during the evening and second because I wanted to see if I could make money this way. The best things about it are that it is profitable most days and I can do it while watching TV or listening to music in the evening. And you can take Gordon’s advice and just not trade if you think you might be off form.

An interesting thing about Woodie’s approach to trading is that it seems very discretionary when you start looking at it but I now have a very systematic set of rules for entry and exit. The discretion come from the "i don’t think the market looks good yet" decision which keeps you from trading until the rules are likely to be profitable. I think that if you were good enough you could program what I do into a computer.

I have two long term systems at present with half my equity allocated to them. I bought both of them and then slightly modified one of them but I really understand the way they react to the markets. I have also bought other systems that I don't trade at the moment and created a few of my own or from books. I allocate equity in pools and basically risk x% of the pool on each trade.

My systems are not the best systems that can be traded. The holy grail for me is a combination that lets me be very relaxed about the weekly ups and downs. What works for me may not work for Gordon, or for Mark, or for you :)


Chuck B
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Post by Chuck B » Sun Sep 14, 2003 3:25 pm

I remember John Henry talking about a bigger than desired drawdown in one of his funds (I think it was Financial and Metals portfolio). He felt confident the system wasn't broken, but he wanted to lower the position sizing (initial risk) to lower the chance of such a large DD in the future (with the obviously lower expected return). What I thought was insightful on his part was that he basically said, "never de-leverage in a drawdown," or something to that effect. If your system is performing as planned, and you find yourself feeling bad about the level of DD, the worse thing to do from a performance standpoint is to lower your leverage. He was going to wait until they reached a new all-time equity high and then lower the position sizing rules.

The above of course assumes a few things such as you are sizing positions reasonably with respect to your portfolio and market volatility since of course if you are 'way out there' on the risk curve perhaps the best thing to do IS to de-leverage :wink: . However, if you are trading at reasonable levels (1% to 2% risk/trade perhaps) and you are maintaining portfolio heat at reasonable levels (i.e. <25% or so max open heat), then deciding in the middle of a DD to lower leverage will simply result in it taking much longer to reach the old equity high (this is usually an exponential relationship too).

The funny thing about this is that I bet only 1 in 10 traders would actually follow through and lower the leverage after they reached a new equity high (as their "feelings" will be substantially different at the point) :lol: .

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