Lesson four: Managing success and failure

Handling drawdown

Drawdowns are a natural and unavoidable part of trading. As a trader, your job is to make sure a normal drawdown doesn’t become a damaging one. The damaging drawdowns not only make you lose significant trading capital, but also mental capital in the form of confidence.

The faster you recognise you are not trading well or that your style of trading is not conducive for the current market environment, the quicker you can limit the damage.

Get out of the fire!

The first step is to stop the losses and take a break from trading, even if it is for only a few days. Don’t worry, the market will be there when you come back. By stepping away you are almost certain to feel better immediately. Once you have had time to clear your head, start figuring out why you were performing poorly.

Were you making a lot of silly mistakes by breaking your rules? Are market conditions not conducive to your trading style? It often is a little of both. For example, some traders perform best during times when the market is trending strongly, but if the market is range-bound they conversely struggle. Knowing this gives the trader a course of action, or inaction. Not trading is a trade: it’s trading in taking on risk for capital preservation until market conditions become more favorable.

Situations outside of trading could also affect your ability to make good decisions. You want to try and get to the bottom of what’s on your mind so you don’t compound your problems.

Once you have identified the cause of your drawdown and taken a proper course of action to fix the problem, you can return to the market with a healthy mindset. You should do so gradually by trading smaller sizes until you restore your confidence back to a level where you can properly execute normal-sized trades again.

Handling periods of success

How a trader handles the good times can be just as important as how the trader handles a drawdown. When you are doing well you are prone to becoming overconfident and sloppy in your efforts. If you do not humble yourself, at some point the market will do it for you.

If you are doing well, ask yourself – am I performing well because I am trading well or only because the market environment is highly favourable? Profitability can mask mistakes. Staying focused on the process can help keep you on the correct course for longer periods of time and delay the inevitable drawdown. This is where journaling and using a checklist comes in handy. Your journal will reveal what you have done well and not so well. The checklist will help you stay on course to making ‘good’ trades and avoiding ‘bad’ trades.

Trading isn’t an easy business, but if you create a plan covering the most important aspects and have certain measures in place for various circumstances which arise as part of trading, you will significantly increase your level of confidence. Ultimately this will increase the odds of achieving success and enjoying markets.