News & Analysis

Avoid the FOUR traps following a major trading capital drawdown

27 August 2019 By Mike Smith



There are few long-term successful traders that at some stage have not suffered a major capital drawdown on their account at some stage.
For whatever the reason the major factor as to whether you continue and get back to “winning ways” or continue to see further drawdowns is what you do next. Unfortunately, there are “traps” that such a set of circumstances can lead to, your aim, if this should happen to you is to avoid these.

This article aims to outline these to assist in developing awareness and assist in your “what happens next” thinking and actions.


Trap 1 – Abdicate responsibility
It is a natural human response when things go wrong to look for someone/something to blame. This is far easier emotionally to deal with than admitting that you have behaved, through actions, in a way that has contributed to a negative outcome.
Although it may be true that certain market conditions, or “trump tweets”, or economic announcements may all contribute to a significant market price movement, the majority of major capital drawdowns in reality occur over a number of trades and of course you have made the choice to trade and as if not more importantly when to exit any trades you have taken.
The reality is of course, that unless you accept 100% that trading action is YOUR choice and that YOU are responsible for your trading results then you are unlikely to move forward and may indeed see further capital drawdowns on your trading account.
Accepting this reality, gives you the drive to avoid the other potential traps and put the right things in place to reduce the likelihood of it happening again.


Trap 2 – Fail to explore WHY it happened?
Beyond accepting responsibility one of your first tasks is to examine potential and subsequently actual factors that may have contributed.
Commonly these can all come under the following:
a. You didn’t know what you were doing due to a knowledge gap
b. You didn’t have an evidence-based (i.e. you have tested it and refined accordingly) specific comprehensive trading plan that guided your actions
c. You didn’t follow your trading plan
d. Your trading system is comprehensive and sufficiently specific but doesn’t work and needs reviewed i.e. a new set of entry/exit criteria
The temptation is, and many traders will go straight to ‘d’ of the above, but again arguably there is an element of “finger pointing” rather than taking responsibility.
The reality is that of the four factors above the latter is the most unlikely cause. Being honest in your review is critical.
Such an honest review will give you clear guidance on which factor(s) you should focus on working on.


Trap 3 – ‘Revenge’ trading
Although this is a term bandied around frequently, let us delve beyond the ‘beermat psychology’ and look a little closer at what this may mean.
In essence, the underlying emotional motivation is to get back to where you were before in terms of your account capital. Commonly this thinking is backed by “desperation”, subsequently influencing actions that often bear little resemblance to good trading practice.

In action, you may see:
• Taking trades when there is no clear set up
• Partial or complete ignoring of any trading plan
• Inappropriate actions further trades go against you (e.g. finding reasons to stay in future trades when there is an exit)
• Trading higher position sizing that you previously had
• Trading each small market move, taking a reverse position even on a trend pause.
• Looking to trade tighter and tighter timeframes

These of course may significantly contribute to further losses as this emotional rather than system- based trading takes a stronger and stronger hold on your actions.

Logically, the following may be more appropriate:
• Give yourself some breathing space to properly review …STOP trading while you complete this (As described above)
• Although easy to say and not so easy to accept the reality is that your account capital is what it is now, not what it was. There was, for many in this situation, a time in your trading where whatever your capital level, your aim was to increase whatever that level was and put actions in place to give yourself the best chance of that happening. Ultimately, even if you strayed from this, developing consistency in appropriate trading plan actions and measurement are accepted by most traders as the way to make this happen over time. So, you need to press the “RESET button”, accept it as it is, and have the goal that through returning to that good trading practice consistently, and filling the gaps you need to. Making this your goal rather than a dollar figure, may give yourself the chance to build capital not just to its previous level but beyond.

Let it go! And do the right things from here I guess is the bottom-line message.


Trap 4 – Position size according to your previous rather than current account level

This final trap for discussion in this article may seem obvious on the surface, but may either be a symptom of the previous point or something that is overlooked (unless of course inappropriate position sizing was one of the root causes of a major drawdown which you will discover in your review).

It is crucial, and hence why we make special reference to it here, that you have a set risk level, usually expressed as a % of your account capital. This will differ from trader to trader but is comply between the 1-3% level as an example.
This determines lot/contract size (dependent on what you are trading) for any individual trade and combined with “stop loss” placement is a critical part of your risk management now and going forward.

You need to recalculate what this is for you with reference to your NEW account size and factor this into your decision making, even if this means you are trading smaller amounts for now.
In summary, major trading drawdowns are upsetting, and although not common often create additional ‘traps’ which may worsen what has happened to your trading capital.


And finally…
Although perhaps of little consolation that many, many traders who now have sustained success, will have gone through this like you, the difference between what happens next and for your trading account in years to come, to your account is likely to be as a result of what you do next.
You have choices to make but avoiding the above four traps described may perhaps assist in ultimately getting to where you want to be with your trading going forward.

Ready to start trading?

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