“Success consists of going from failure to failure without loss of enthusiasm” – Winston Churchill

All traders wish they could not lose. I do not think any trader wakes up in the morning actually expecting to lose. However, loss is simply a part of trading (and of life) and the fear of loss is a path to the “Dark Side” (as Master Yoda put it).

Ray Dalio is famous for creating a culture in Bridgewater  that cherishes failure: more often than not, it is through failure that we can actually learn something. So in this final article of 2017 let us share what we have learned during our largest failure to date: our Maximum Drawdown period.

Activity vs. Profitability

The first lesson is a reminder that quality trumps quantity at every turn. By trading less, we have actually had better returns recently. As an extreme example, from December 1st to December 15th  we only took 2 trades with our London Open model, ending positive 0.5%.

On the contrary, before and during our drawdown period we were much more active and somewhat less selective of our battles. The message is clear: it is entirely possible to produce better results with less activity. Stated in a better way: do not force trades. 

Many traders think that they need to be active every day. Many traders will sit in front of their screens “looking” for trades. At a certain point, we too fell into this trap. But we have very much learned our lesson: profitability does not require much activity at all. Do not attempt to “look” for trades, but instead wait until they “stick out like a sore thumb”. Only risk your capital on the most evident scenarios for your trading model.

This is one reason why we sought to develop alternative models in 2017, and have come out with End of Day Signals and  Newsflow Signals. By having multiple models to work with, we can be more patient with each single model and seek out only the best situations for it. This way we can maintain decent activity levels without the risk of diluting our profitability.

Trade Management vs. Trade Selection

The second evident lesson has to do with trade management. As we have noted previously, trade management is not a panacea.

In the chart above, the burgundy line represents our actual equity curve for short-term and intraday trades taken during the drawdown period. Here is how we simulated the other equity curves:

  • The green & yellow lines attempt to remain in the market so long as there is continuing momentum, by using a Supertrend as a trailing stop. They also close 50% of the position upon reaching 1R.
  • The blue & orange lines attempt to do the same thing, but remain fully invested and either hit profit targets or get stopped out with the trailing stop. This is a slightly more aggressive management model.

The main lesson is that trade management alone cannot turn the situation around. It can drastically worsen the situation, but it cannot turn a series of poor trades into a good equity curve.

Vice-versa, in the chart above we have gathered the swing trades (multi-day in nature) taken over the same period. The original equity curve itself is not enviable, but it’s not a disaster. However, using the same trade management simulations as above, the results could have been enhanced to a significant degree.

What we learned is simple yet effective: trade selection really knowing what the best conditions are for your model – is what helps keep losing streaks short and drawdowns contained in size and duration. 

This poses the question: how do we select “good trades”? Is it possible to only select “good trades”? The answer of course is “yes”, it is possible to select good trades but what constitutes a good trade is contingent upon your trading model.

In our Forex System Development Workshop, we attempt to help traders understand what principles they are building their systems upon. If you know what your model is supposed to do, you will also know how to facilitate it’s job.

Trading Out of  a Drawdown

Finally, let’s address the one thing we did right during our drawdown period. Possibly, it’s the one thing that kept us alive: our position size.  When we noticed the performance drop, we immediately cut our position size to 1/4 of it’s normal size. This safety precaution is what has allowed us to analyze and adjust our model gradually.

The lesson is actually twofold:

  • you should always be able to identify whether your trading model is performing in line with expectations or not;
  • you should reduce your risk when results begin to deviate from their past course.

Since your position sizing model depends on the quality of your system, when the system is working well you can push towards your objectives; but when you notice a performance drop, your position sizing needs to assist you in preserving your capital.

Over to You

2017 has indeed been an intense year for us, as we simultaneously had to contain the damage our drawdown could have produced, learn the lessons and make the necessary changes. We did not uncover anything new or groundbreaking. We have verified with our own data what the Market Wizards have been telling us for nearly 40 years.

Sometimes the only way to really learn a lesson is to make the mistake yourself and find a way out of it. Hopefully you have found our mistakes entertaining and instructive. We have come out of our difficulties with 3 trading models, an enhanced education section and much more experience to share.

2018, here we come…

About the Author

Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.