Mastering the Art of Recovering from Trading Drawdowns
7 Key Steps and 1 Practical Activity to Survive and Thrive drawdowns
In basketball, when there’s a player who’s not scored for a while it’s usually a confidence issue.
They are not taking the same risks as before cause they’ve lost confidence in their ability to score.
The same happens when a trader faces a drawdown.
The trader starts to take smaller risks, missing trades and cutting winners short, all based on fear.
So if you were a basketball player who needs to regain confidence, how are you gonna do it?
Kobe Bryant said, “Confidence comes from preparation. When the game is on the line, I'm not asking myself to do something I haven't done a thousand times before”.
How can you prepare yourself to overcome a drawdown?
In this article, I give you 7 key steps to overcome drawdown and 1 practical activity in the end to practice a new emotional response.
Let’s dive into it.
If you want to be at peace with your results, the first thing you gotta do is…
1. Manage Expectations
Every single strategy has an upside and a downside.
You can’t blindly trade one strategy and only look at the good side of it - the growth of the equity curve - without expecting to have some kind of drawdown.
They both will happen if you keep trading it.
Problems show up when you change your performance based on where you’re at on the equity curve.
So the first thing you wanna do before experiencing a drawdown or even before starting trading a strategy is: Know the upside and the downside of your strategy.
If you’re a newbie starting out with a strategy, just accept that you’ll have both sides, and as you have more experience, you’ll get to know what the upside looks like - the potential your strategy has - and the downside - how the losses look like.
The more you trade your strategy, the more you can trust the statistics it delivers.
Confidence in trading doesn’t come from knowing you’ll win, it comes from knowing both up and downsides and accepting them. So when they come, you’re expectations are aligned with the reality of your system.
2. Set Drawdown Rules For Your Strategy
Establish loss limits for the day, week, and month.
If you hit that limit, walk away.
Don’t dig deeper into your grave when you’re on a drawdown.
Just take it as you’re done for the week. Stop trading and come back the next week feeling fresh.
The same applies outside of a drawdown. Having these types of rules protects your capital against impulsive behavior and if you become aware at an early stage you can actually stop the evolution of the emotion and avoid bigger disasters.
3. Visit The Big Picture
Fear narrows your perception, confidence widens it.
In losing streaks, losses, or drawdowns, you need to refer to something that gives you the confidence back so you can put things in perspective.
Revisit:
Your strategy's statistics;
Trades of the past 6 months;
Methods and ways you overcame past mistakes.
Under rough periods of time, looking at this evidence will reinvigorate your confidence and motivation.
4. Keep Executing
Self-doubt will take over when in drawdown:
What if my strategy doesn’t work?
What if I’m not made for this?
What if I’m insisting on something is not for me?
What if I add this confluence to my strategy?
Recognize that these are illusions your mind is making up based on your fear.
Distance yourself from this fear and look at it from an observer’s perspective. Get curious about it. See how it affects your thoughts and self-talk.
In drawdowns, you have to keep trading just like you’ve been executing before.
This is the best time to prove that you and your strategy can thrive under tough conditions.
Don’t let the place you are on the equity curve dictate the way you trade. The markets are the same, and your strategy must remain the same, or else you’re gambling.
If you have a proven system that works, you want to continue trading that system in drawdown. This is when being on a losing streak presents the best opportunity.
5. Know Your Strengths
Confidence comes from knowing your game and your strengths.
Simply put, you have to know who you are as a trader.
More often than not, a trader going through a drawdown tends to make things too complicated or has drifted away from his/her strategy.
Be the best version of yourself!
Therefore, take the time to sit down and write out what made you profit in the past - your personality traits, your strengths, and how you overcame past challenges.
In doing so, you can create a road map for getting back on track.
Re-use what worked in the past.
6. Use Body Language
We are not the result of our emotions. Our emotions are the result of our actions.
The way you carry yourself has a bigger influence on your mood than most people imagine.
Think about it, how does your body language look when you feel nervous or not confident?
You start avoiding eye contact, maybe hang your head, bite your nails, rub your hands... That's usually a natural reaction of our body to a certain situation. It's simply our nervous system telling our brain that it's not comfortable in the current situation and wants to change (fight or flight).
Now, because our brain associates our body language with a particular mental state, we can actually turn this around.
Instead of your natural reaction to a challenge, try to stand up high, look forward and raise your chin. It feels unnatural at first, simply because the pattern of our body and mental state don't match yet.
However, if you can manage to "hold" that at your trading desk and repeat it in several sessions, you'll already start to feel an inner sense of relief.
Try it before you enter your next trade.
Speak out loud confidently your thought process on that trade and you’ll find it easier to decide.
It’s not that the confidence will change the result of the trade but helps you execute flawlessly!
7. Commit to the struggle
If you wanna get better at dealing with drawdowns, you have to experience them.
Without tough market situations, you don’t have opportunities to practice new responses. See these drawdowns as challenges rather than giving them a pessimistic look.
Remember that no great trader was free of drawdowns, what made them good was exactly that they overcame them multiple times.
Commit to the struggle and realize that these phases are there for a reason; to challenge you as a trader and as a person.
In looking at these times as opportunities to develop, you build resilience and tolerance to withstand even greater challenges.
Be sure to surround yourself with positive, tough coaches/traders who will keep you accountable.
Practical Activity - Emotional Ladder
So in order for you to practice, here’s an exercise that will prepare your mental state to face tough situations. It’s used in therapy and it can be adapted to trading.
Create a list of 7-10 market situations starting with the least frustrating/difficult to handle and moving up to the most difficult and challenging - the ones that would be most likely to set you off.
The work begins once your hierarchy is done. Put yourself in meditative mode: close your eyes and focus your attention. Slow down and deepen your breath.
Now, imagine a relaxing situation in your mind - a walk on the beach or in nature - while you keep breathing slowly and deeply.
Now, visualize yourself in the first situation of the hierarchy vividly. For instance, one trading loss. Experience all the emotions that the situation may cause you, stress or anger, don’t suppress them. Continue breathing deeply, and aim to control your body.
Once you become completely chill in that situation, move on to the next scenario of your hierarchy and do the same until you get calm and relaxed.
Repeat this until you go all the way to the worst-case scenario (for example a drawdown, or losing streak…")
Notes:
Add to your hierarchy list as many situations as you want. Don’t start the meditation until you have at least 4 different scenarios. Examples: one loss taken without mistakes, one loss where I made a mistake, 2 losses in a row, a missed trade, a re-entry that stopped me out, a loss where I widened my stop loss, a losing streak, a trade where I took profits too early, a trade where I didn’t take profits and ended up in a loss… Think about all your usual mistakes to complete the list.
Don’t aim to go from scenario 1 to the last one all in one session. Rather, listen to yourself and only move to the next scenario if you’re able to slow down your breath and relax your body toward those emotions.
Don’t aim to control your emotions, let them flow. The only thing you want to control with this exercise is your breathing. If you can control it, you can partly control the emotion.
Practice this exercise aside from trading. Our minds cannot distinguish between real and imaginary content so you’re using this brain feature to your advantage with this exercise.
These rehearsals need to be intensive and consistent - repetition is key here.
What you’re doing here is pairing a stressful situation that triggered you in the past with physical calm and cognitive focus. When you reprocess your triggers while managing your mental state, you learn how to undo the fight or flight response.
Be patient with the results, it takes deliberate practice to get comfortable in the midst of old triggers.
Feel free to email me your feedback on this exercise.
Summary
Set drawdown rules for your trading to perform always at your fullest mental edge;
Visit the big picture to help your brain reframe and gain confidence;
Keep executing your strategy and make sure you’re not deviating from it;
Write down the strengths that helped you win in the past, double down;
Use body language to help you trade confidently;
Commit to the struggle, see drawdown as a challenge that showed up because you’re finally ready to overcome it.
Use the emotional hierarchy to practice new emotional responses.
With love,
Sara
Whenever you’re ready to elevate your trading performance, here’s my 1:1 coaching.
Wonderful Advice all around. What has resonated with me is embracing fear and knowing whatever the outcome it's a chance to grow and learn this has helped me with the thoughts of losing and all the other assumptions that go along with that.. Thanks for your work.
Kobe! Not Koby