Despite everyone’s best efforts at formulating a great trading system, following it and controlling your emotions, the inevitable losing period can come. It is important to know the various strategies you can use to help handle the losing period. It is also helpful to know the variables you can tweak to determine which style suits you best.
There are dangerous ways and ultra safe ways to handle a draw down period. Your choice which one you want to use.
Variables You Can Tweak
1. Trading System – If you don’t believe in your trading system anymore, then you can obviously switch to a completely new trading system.
2. Risk Per Trade – You can change the risk per trade higher or lower.
3. Trade Frequency – You can change how many times you place trades on average either higher or lower.
Strategies For A Draw Down Period
Now knowing the above variables, you can mix them together to form various strategies you can use to handle a draw down period.
There are approximately seven different ways you can handle a losing series of trades. Seven different ways you can play a drawdown period.
1. Increase Risk Per Trade And Increase Trade Frequency To Attempt To Make The Money Back Even Faster.
Let say for example you were risking 2% per trade and placing an average of 5 trades per month. You find yourself down 6% and are trying to recover. You ramp up risk per trade to 3% per trade, and at the same time you increase your trade frequency to an average of 10 trades per month.
This is obviously the most dangerous strategy that can feed on itself and result in blown accounts.
2. Increase Risk Per Trade To Attempt To Get The Money Back. You Keep Trade Frequency The Same.
Lets say you risked 2% per trade, and placed 5 trades per month. You find yourself down 6% and trying to recover. You ramp up your risk per trade to 3%, but keep the trade frequency the same at around 5 trades per month.
This is the second most dangerous strategy because while you are keeping your trade frequency the same, you are still increasing risk per trade.
3. Keep Risk Per Trade The Same. Increase Trade Frequency.
You don’t risk any more on your trades. But you increase the trade frequency to attempt to find more opportunities during the month. This is similar in riskiness and danger to number two above.
4. Keep risk per trade the same. Keep trade frequency the same. You just keep executing your system and following it. Nothing changes.
Let’s say you risked 2% per trade, and placed 5 trades per month. You are down 6% and in order to recover you don’t change anything. You keep executing your system to exploit the edge that you believe you have in the market. After all, if your trading system is good then it should recover on it’s own without changing any of the parameters.
If your trading system has a true edge, and you are risking the proper amount per trade that will not lead to big losses if a consecutive series of losing trades occur, then you just need to keep doing what your doing and risk the same amount and look for the same trades. Your account will recover.
This is the most plausible strategy to implement. It is right in the middle between the highly dangerous and ultra safe strategies.
5. Keep risk per trade the same, but lower trade frequency. This is starting to get more on the safe side.
You don’t risk any more on your trade. But you do lower your trade frequency. Therefore if you were placing five trades per month on average, you may lower it down to two or three. You start to be more selective in your trades and attempt to find the bigger winners. The trades with better risk reward.
6. And finally the safest is to decrease risk per trade and decrease trade frequency.
With this strategy you retrench by lowering risk per trade and lowering your trade frequency. If you were previously using 2% risk per trade and five trades per month. You may drop your risk down to 1% per trade and only look to place 2-3 trades per month.
Now you may ask, how are you supposed to recover from the draw down when you are cutting risk per trade and lowering trade frequency? That is where nailing the big winners comes into play. Nailing the 5R, 10R, 20R trades. You are more selective in your trading so hopefully your win rate increases a bit and/or your winners are bigger.
This is by far the ultra safest way to recover from the draw down period.
There is another special method which involves increasing risk per trade, but at the same time lowering your trade frequency drastically. Therefore if you previously risked 2% per trade and placed 5 trades per month, you could risk 5% per trade, and only place one or two trades per month. How risky this strategy is will depend on what the winrate of your system is. If your win rate is extremely high, then it can work. If your win rate is low then it can backfire and you should choose one of the more safer methods above which involve lowering risk per trade and/or lowering trade frequency.
The final method is to decrease risk per trade, while increasing trade frequency.
I explain the relationship between win rate and risk reward in my previous blog posts.
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