Here’s what’s inside this episode: What is “reframing your losses?” How do you “focus” on your trading targets? Why drawdowns do *this thing* to your system execution… and the importance of aiming for the “bigger fish.”
You’ll see some of the important factors to consider when making decisions in the midst of a drawdown, how to “reframe” and how to avoid making one of the “classic” trading mistakes.
Darren offers a tip for finding your comfort zone as a trader and for defining the best strategy for you.
Download (Duration: 18:40 /21.3 MB)
In this episode:
00:46 – still too attached
02:43 – reframing losses
05:19 – building bridges and skyscrapers
07:03 – black swan events
08:18 – in the midst of a serious drawdown
09:33 – what feeds into a gambler’s fallacy?
11:40 – a big trap for traders
15:13 – focus on single trades
17:22 – a number’s game
18:13 – the easiest way to earn money
Do my next twenty trades fit with my system? [Click To Tweet].
Keep a journal and record of trades that you did. [Click To Tweet].
Don’t throw a profitable trading system because of a drawdown. [Click To Tweet].
Darren: It’s about that mindset, it’s about seeing trading as being the numbers game and trying to work the numbers in your favor. It’s not about being able to read the market and pick the exact moment/time to get into the market and read the conditions and always pick the right exit…
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome to the Two Traders Podcast. How are you today, Darren?
Darren: I’m good. Thanks, Walter.
Walter: Cool! We have this question from a listener and the question is: I’m still too attached to single trade instead of having a focus on the bigger picture. This leads to bad decision when managing my trades, like cutting when they’re short.
What should this trader do? I have some ideas, Darren, but I’m interested in your thoughts.
Darren: I completely get where this trader is coming from. It’s something that I used to do all the time and you need to get a way of reframing your results. What’s something that’s worked for me is I used a piece of software that catalogues all my trades for me. Then, I can go to it and see what my results were week on week, what my results were month for month.
I can compare this year to last year and all of that information is available at the click of the button for me. Whenever I’m having a bad, whenever I can feel myself being affected by a few losses, a couple of trades, I will go to that — let’s say, I’ve had a bad week so far — I’ll go to that and look how I’ve done for the year so far and just put it into perspective.
Let’s say, I’ve lost a hundreds pips already and it’s only Tuesday. I’ll go to my results this year so far and I’ll say “Well, I’m still two thousand pips up for the year so it’s not significant”.
It’s just reframing those losses in the bigger picture. I don’t necessarily have to use that, just sort of go along with that. I’ve got a target for the year, how much I feel I should achieve for the year based on my testing and how I’ve traded before.
I’ll also have weekly targets and monthly targets. I can always reframe any series or even single losses and put them in perspective of a bigger picture. It’s called “reframing” and it’s really good. There are other ways of doing that but that’s my way of reframing losses and it works really well for me.
Walter: Do you use historical data as well? For example, let’s say you’re trading a system that you’ve been trading for the last five years. Do you look back and say “Well the last five years I’ve seen a drawdown or something like this seven times, so it’s not really unusual”? Do you do things like that or is it always in… is the background always sort of the overall game versus this little bliff?
Darren: No. If I have a really bad drawdown in a week and I feel it’s significant and there’s something wrong, I’ll go back to see how many times I’ve had a similar bad week and again put it in perspective: “Okay. I get four or five of these every six months, every year so, it’s nothing unusual. It’s just normal market behavior. It’s my system playing out.” Again, it reframes for me.
One I do always like to refer other traders to, if they perhaps haven’t got a lot of their own data is the incomposite, fundacite trend trader that has been going for forty years. We should a post a link in here.
He’s been going forty years and he routinely has twenty percent, twenty five percent drawdowns but he consistently makes profit year in, year out. All of these results are available online.
I’m sure that whenever you say “I’m in one of those drawdowns”, I’m sure you just don’t have to reframe it anymore. But, the day are set for him to be able to go back and say “Well, this is not unusual. This is part of my system. It’s not significant so I should just persevere.”
Walter: That’s great! I’d love to see that link. I haven’t seen that. The other thing I would say is you can anticipate this — and I know this might sound a little bit weird to some people. I’ll post a link under in the shownotes here for you to play around with this.
We know like the same statistics that we used to build bridges and skyscrapers and things like that, you can use those numbers to highlight the likelihood that your system is going to have a drawdown of x percent.
Let say, it’s twenty percent. Let’s say, you think if you lose twenty percent — if you build up your account and it’s up to five hundred thousand EUR and then now let’s say you’re down a hundred thousand EUR which is twenty percent — you’re going to start to freak out.
How do you avoid that? Well the easiest way to do, to figure this out, is to go through run your numbers and you’re going to need your win rate, your reward/risk ratio and the amount of risk that you have on this trade.
Now, obviously, you’re probably not going to build a change in your win rate and you’re probably not going to change your reward/risk ratio unless you do something drastic with your exits.
If you keep everything the same, the only thing you really have control over is what you’re going to risk per trade. So, by adjusting that upward or downward on the calculator — that’s posted in the shownotes for these episodes — you can see what is likely to occur.
You might find out that you have ninety five chance of that twenty percent drawdown. If you reduce your risk by a third, you might find that ninety five chance of the twenty percent drawdown falls to thirteen percent chance, something like that.
These are things that you can do to play around, but I know some people who probably listening to this are going “Well, yeah. That’s just statistics, you never know what’s going to happen in a real life.”
That’s true because it’s probably more likely that the chances are slightly higher than anticipated using that calculator. That’s probably true because we know that we have these black swan events every few years rather than every five hundred years. That’s true.
The more important point here is if you can anticipate these and you can adjust your risk in sort of decrease the likelihood of something like that happening then, the next question I have for you is: what are you going to do about it?
If you know, for example, you’ve got a thirty percent chance of a twenty percent drawdown and you know that if you’ve been trading for four years and then you hit this twenty percent drawdown, you built your account up quite a bit.
Let’s say that you’re not really making routine with goals, then it’s going to hurt. What are you going to do about that? Are you going to close down and say “Well, the system doesn’t work anymore. The market has changed”.
Or, you’re going to change your system and say “Well, I’ll adjust this” because something “screw you” is happening.
Or, are you going to say “well this is the drawdown that I anticipated. Now, I’m going to take two weeks out. I’m going to get away from the charts. I’m not going to take any trades. I’m going to do my backtesting. I’m going to build up my confidence again and I’ll jump up in the game.”
These are the sort of things that you need to consider long before this happens because when we make up the rules after what happens in the midst of a serious drawdown, that’s when I think mistakes are made.
I know you probably don’t agree with everything, Darren, about what I just said. I’d be interested to hear sort of what you’re thoughts are in regards to anticipating and then dealing with the dreaded drawdown.
Darren: I agree with what you said. It’s not how I go about it. That doesn’t mean that is wrong. It’s just your technique of dealing with it. I’ve heard that you’re pushing the fact that, generally, traders will perhaps be looking at the positives too much and trading too much size.
Those individual trades can fray you off because you’re expecting to go straight into a winning streak and it’s gone into too large a position and you’re uncomfortable with that drawdown. Is that kind of what you’re saying?
Walter: Obviously, one of the common things that happens in trading — and all you have to do is have a look at some of the forms out there and see — one of the earliest things that you’ll ever come across is the “Martingale Method” which is: I had a loser so I’ll double my risk on my next trade, so forth.
That just feeds into a gambler’s fallacy. Gambler’s fallacy being, of course, the trade that I just took has some bearing on the next trade that I’m going to take which, of course, is not true. They’re completely independent.
Some traders, that’s their mode of operating. They know that they’ve had a drawdown. They’ve had seven losers in a row and so that means that the next trade, the eighth trade, is more likely to be a winner or whatever.
The number that we know is the win-rate. If your win rate is sixty percent, the next trade isn’t more likely to be winners. It’s sixty percent more likely to be winner just as the seven trades were, provided of course that you’re following your system.
My concern for traders who get into drawdowns is that they’re going to throw a profitable trading system they’ve worked so hard on to validate and build their confidence into the scrapheap because it’s had a drawdown, or even worse, they’ll say the market has changed.
For example, as we record this and — it doesn’t really matter when did we record this — there is some news in the markets now about the GBP. The GBP has been jumping around like a Mexican jumping bean.
It’s drawing a lot of traders into a bit of a fit because they don’t know what to do. My question is, for these traders who’ve been trading the GBP for a long time, does this mean that your system doesn’t work anymore?
Does this mean that the market has totally changed and that you should find something different? What does this mean? I think it just means that you’re in a drawdown. It’s probably maybe the worst drawdown that traders have seen trading the GBP in x number of years.
I think that’s really all it means. These systems, particularly the very simple systems, will still work on the GBP in the future. It just happens to be a bad time to trade those systems now.
That’s really all I believe and I think that the trap, the big trap for a lot of traders, is to change your system or give up on your system and build something else from the ground up just because you’re in a drawdown. Typically, that’s because they’re risking too much.
Typically, what we’ll look at is this is what my equity curve could look like and we don’t look at those little dips along the way.
Darren: We want to get to that place where we’re finally comfortable; where even though we’ve done the testing, we like the system, and the figures are all good, we want to race to that point where we no longer have those doubts.
“This is it. I’m never going to have to change my system again. I’m happy with it.“ We rush to that point and, unfortunately, it takes — I don’t know what the number is — but you have to go through a certain amount of pain before and stay resolute to get to that point.
When we start out, we’re not prepared to go through that pain and we’ve rather start fresh and say “Okay, that doesn’t work out. I’ll start again.” How many trades? I don’t know.
There’s this notion of letting the numbers play out, especially with how the wins and losses are distributed regardless of your win rate. Letting the numbers play out and seeing consistent profit over long time, you have to go through a lot, like a pain barrier to get to that point.
I think again with loss aversion, we find that really difficult and uncomfortable to do as humans, especially when we’re trying to make our incomes support our family and achieve all the things we want financially and what we’re doing in this world. It’s very difficult to do.
Journaling and keeping a record of your trades really helps. I know I’ve wasted months and years of time by trying different things and not keeping records of what I’ve done. Just, basically, being impatient and rushing things.
When I finally settle down and stopped with something for any amount of time and kept these records then, I could really prove that the strategy and what was working and what I was doing right and wrong and just some sort of perspective and then really make some progress with my consistency.
It’s natural to feel bad from a single trade. The first trade of the week, really, is I’ve got a fifty percent win rate. First trade of the week is really always a loser for me and it’s still painful.
You still get those feelings rush through you that “Oh, maybe I should start on the next bar and maybe I should just wait until London open.” Then suddenly, all these insignificant things are coming to your mind.
With the course of time and with more trades, you just get better in dealing with those things and seeing them for what they are, which is really just loss aversion, fear and pain and emotional response to having something negative happen.
Walter: If you’re having this issue of focusing on single trade instead of focusing on the big picture, maybe one way is to change your days. Instead of basing your decisions or your focus on one trade, you can focus on some chunks of trades, look at the next twenty trades.
Ask yourself this question: do my next twenty trades fit with my system? Do I have a sixty percent win rate? Do I have twelve winners over the next twenty trades?
That way, you’re just moving the line further down the horizon so that you’re not tempted to change things because that’s the road to madness. We’ve all been there. We have the last trade that didn’t go that far and I didn’t reach my target. It came back and it was a loser. Next time, I’ll take the profit early.
Of course. the next trade not only hits your target, you get out before it hits your target. You don’t make as much money then it goes another fifty percent in your direction quite easily.
These are the things that just leads you down the road to crazy town. You don’t want to do that. What you want to do, instead, is look at the bigger picture. Look at chunks of trades. Look at the twenty, thirty trades. That’s another way of doing it.
If you really want to study these things and make sure that everything is and if you’re a new trader and you’ve just recently go live, then do that. Look at whether your win rates holding through twenty, thirty trades.
Do it like that instead of changing everything because the last five trades weren’t so good. That might be one way around it. Those are my thoughts on this idea of how do I focus on the big picture when these individual trades are affecting me so much. Do you have any closing thoughts on this, Darren?
Darren: I’m one hundred percent in agreement with what you have just said because that’s how it summed up how I see trading. Trading is, for me, a number’s game and it’s not a case of you’re putting a good trader and say “pick a winning trade and pick a winning exit” and he’ll be able to do that.
That’s not what traders do. Good traders can trade over a long period of time. A lot of trades, they’ll have good period and bad periods over the long run, they’ll make more than they lose.
It’s about that mindset. It’s about seeing trading as being a number’s game and trying to work those numbers in your favor and it’s not about being able to read the market and pick the exact moment/time and to get into the market and read the conditions and always pick the right exit.
To an element, it can be about that but if you think that it’s only about learning that skill then you’re missing the easiest way that there is to make money and that is by letting the numbers play out in your favor.
Walter: Absolutely. I appreciate your time, Darren, and looking forward to hearing from you in the next episodes.
Darren: Okay, Walter. See you soon.
Walter: See you soon. Bye.