There’s an old Chinese saying: ‘Fall down seven times, but stand up eight’.
But there’s another saying that tells us insanity is repeating the same thing again and again, expecting different results.
Traders need to be resilient. We need to take the knocks and keep persevering in the markets through the rough patches.
But at what point does resilience turn into blindly ignoring that something just isn’t working?
Here’s a scenario…
You’ve had four losing trades in a row.
You’re probably feeling pretty irritated. You’ve more than paid your dues now – you definitely deserve a winner. And then it hits you… a fifth loser.
Common emotions for traders at this time are:
- Frustration: why has this happened to me? I followed my trading rules to the letter.
- Anger: this must be someone’s fault. Perhaps my broker is chasing my stops or the system developer is running a scam.
- Doubt: this strategy doesn’t work. I shouldn’t place the next trade.
I have gone through exactly these kinds of emotions many, many times myself.
The overwhelming urge I feel is to either stop trading the system altogether (which also helps me to close my eyes to the drawdown I’ve suffered), or to start making changes to my strategy – the kind of changes that would have cut out those last few losing trades.
Both of these are emotional reactions – what I need, instead, is a rational approach that takes into account my need to ‘do something’, without making crazy snap decisions.
A plan…
1. Has your strategy been properly tested before you started live trading?
If you tested it yourself and are happy that you did a thorough job – great. If someone else tested it – do you have confidence in them? If you do, that’s fine.
If you’re in any doubt, I recommend that you go back to paper trading this strategy.
If you carry on trading, whilst still having all these feelings of doubt, it is unlikely that you’ll be able to keep disciplined and consistent with your trading. You need to believe in the signals you’re following.
2. How likely is it that your system will hit 5 losing trades in a row? Let’s say that your system wins 60% of the time (losing 40% of the time). To calculate the chances of losing 5 in a row, it’d be the losing probability (0.4) to the power of the number of losses (5)…
0.4 * 0.4 * 0.4 * 0.4 * 0.4 = 1.024%
So, in approximately every 100 trades you can expect to get a run of 5 losses. (Of course, losing runs won’t fit neatly into this pattern – you might get two runs of 5 losers in your first 100 trades, and none in the next 100 trades).
Is what you’re experiencing wildly different to this?
If not, perhaps you can relax.
3. But what if your system is properly tested, yet still you’re suffering from that gut-gnawing feeling that a losing run can bring?
In that situation, there are two vital things that you need to protect: your capital and your sanity.
Just because a trading strategy has an immaculate track record does not mean that it’ll keep working that way forever.
Some of the best strategies will suddenly stop working, or go through rough patches that throw out the traders who don’t have a plan for the bad times as well as the good.
The first step is to reduce your risk. Cut your staking levels downs – sure, this means that it’ll take longer to make back those losses you’ve just suffered, but the focus at this moment is on preserving capital rather than making money.
If you’ve had a bad drawdown, you can also stop live trading completely, and come back to the markets refreshed.
But, even if you’re not live trading, keep following the system with demo trades – when your confidence is up, you can come back to live trading.
However, a word or warning: if you jump out of a system after every losing run, and then come back in after a run of winners, you’re going to end up constantly chasing performance, missing the winning runs, and catching every losing run.
If runs are losers are causing you too much pain, chances are that you’re over-staking in the first place.
The golden rule for traders is to risk 1–3% of your fund on a trade, and it’s tempting to stake as high as your trading fund will allow you, so that you can make money as quickly as possible.
However, risking 0.5% of your fund is a perfectly valid way to trade.
Sure, you may not hit the same highs – but you’ll also avoid the lows! And it may well keep you in the trading game a lot longer than other traders.
