Regardless of your investing or trading strategy, prowess or experience, there will be times when everything (and I mean “everything”) goes wrong. I share this experience more as an educational piece on the realities of trading than anything else.
For me personally, last week was one of those weeks where nothing worked. While the S&P 500 and the Russell 2000 had fairly mild pullbacks of around -0.4%, my Tactical Alpha portfolio got hit with a drawdown in excess of 4 percent!
This was certainly the worst week of 2015 for me and probably among the 5 worst weeks in the last 3 years.
To paraphrase Murphy’s Law, it was a week when everything that could go wrong did.
I would be lying if I said that, after doing this for many years, it is easy to just shrug off a week like this and skip merrily along without missing a beat.
What happens in reality is that the emotional part of the brain “freaks out” and causes traders to start questioning and second-guessing everything.
Unchecked, this can be very dangerous because it could lead to rash changes to trading plans and strategies and a subsequent vicious cycle of flailing and directionless-ness that leads to even more drawdowns.
What To Do?
As hard as this may seem, in my experience the best first thing to do is relax, step back, and let the dust settle for a bit.
After this I like to conduct a thorough review of all the trades that went wrong to try to understand what happened and what can be learned.
After doing such a review, here are the three key reasons for my not-so-fun week:
- Wrong Positioning – Given the major indices breaking out to new all-time highs in the previous week (i.e. Russell 2000), my portfolio was positioned long and anticipating the continuation of the overall uptrend, especially among small caps. Aside from Monday, the market did not make much progress and spent the rest of the week drifting lower, which did not help my long positions.
- Setups Stopped Working – Setups that worked extremely well over the last three months suddenly seemed to stop working this week resulting in the majority of the positions getting stopped out. The setups that I gravitate toward usually involve pullbacks in strong stocks to significant support. It is always expected that a certain percentage of any trading setups will fail (that’s why every trader must use stops), but this week nearly all did for me. This could indicate that there is a larger market composure change afoot but it is too early to declare this with any certainty.
- Murphy’s Law (Of Course) – Adding insult to injury this was also the week when I was on the receiving end of the market’s cruel sense of humor. Perfect example was AMBA, where I tried building a position on Monday anticipating an oversold bounce off the 94-95 support and toward 108-110 resistance. AMBA did exactly as I envisioned it would. Unfortunately for me this move happened after my position was stopped out in the 93 area.
Following an experience like this and the above post-mortem analysis, the biggest question is always: Is there anything that I could have done to avoid this and/or prevent it from happening in the future?
Looking at the key points above, it seems to me there was very little I could have done on both fronts for the following reasons:
- Wrong Positioning – As a trader who relies primarily on market trends and price action to determine the best course of action, second-guessing market breakouts to new highs and trying to fight the trend is simply not smart. In hindsight doing this last week would have led to better results, but this is definitely not a winning or sustainable long-term strategy. There will always be times when the market proves us wrong, but it is nearly always more profitable to go with the prevailing trend until it changes.
- Setups Stopped Working – This is another instance where it is impossible to predict how many setups will fail. The best we can do is make sure we always take setups with the best possible risk/reward and do everything we can to minimize potential losses and protect capital.
- Murphy’s Law – By definition, this is the one where we have the least control. Getting shaken out of trades may be extremely frustrating but it is impossible to avoid. As a wise trader once said: “The only way to avoid getting shaken out is to stop trading.”
I realize this may be a disappointing conclusion to any of you looking for easy ways to minimize or avoid drawdowns in trading, but it is the reality of this business and as traders we have to accept it.
Accepting losses, however, does not mean we have to relinquish control and put ourselves at the mercy of the market. Quite the opposite.
To succeed as traders we have to accept losses on individual trades as well as drawdown periods but also must have a way of controlling and minimizing them. Thanks for reading.
Read more from Drasko’s blog, NoanetTrader.
Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.