The Inevitable Drawdown

Over the last two weeks, I’ve been in a bit of a drawdown in my day trading, meaning that I’ve been losing money and taking away from previous gains. I dug myself a hole, and now I’m working on recovery. I have gone through this more times than I could count, but I don’t know that it gets easier. It is just never fun to be in a drawdown. It’s frustrating, it’s disappointing, and it’s confusing. Nothing about it is good, but it is an inevitable part of being a day trader. So, in today’s article, I’m gonna discuss how I approach these drawdowns.

Types of Drawdowns

First of all, I think it’s important that we set the stage with a little bit of context. Not all drawdowns are the same. I would say having one or two large red days that give back a week or so of progress constitutes a drawdown. Having one or two red months that give back months of progress also constitutes a drawdown but is certainly more concerning and more substantial. On the other hand, drawdowns that extend for years are not a drawdown but are just an indication that your strategy is not working, as you can imagine. Over the years, I have known traders who have experienced each of these types of drawdown scenarios.

In the first scenario, which is the least severe, we’re talking about a drawdown where you’re giving back perhaps a week or two of profit. This is the type of drawdown that I experience the most frequently. It happens several times a year that I dig myself a little bit of a hole, and it takes a few weeks to recover. In my latest example that I’m currently recovering from, I put together five consecutive red days. It’s the second time I’ve done that this year. It’s certainly not fun.

My Latest Drawdown

It began with a red day on a Thursday, where I lost about $500. It felt negligible, and I wouldn’t even consider that a drawdown. That’s just a small red day. Then, on Friday, I proceeded to lose about $5000, and I was 100% giving in to FOMO. There was a stock that had made a really big move on Thursday. I had missed it because the bulk of the move was later in the day, and I came in bright and early on Friday morning. I jumped in with a 5 or 6000 share position. I thought I would catch a quick continuation trade, and instead, I lost $5800 in just a few minutes of trading and I hit my max loss. It was not a great way to go into the weekend. It was two red days in a row, but not a significant drawdown either. It was just a little disappointing.

Then, on Monday morning, I sat back down and had a third red day in a row. It was not quite $5000, but it was a substantial red day. Come Tuesday morning, I lost $4500 and had another red day. I tried to exercise composure and hold it together, but I wasn’t able to do it. On Wednesday, I finished green before commissions, but only by about $30. I was red about $300 on the day after fees and commissions. On Thursday, we had a market holiday for Thanksgiving, and on Friday, I bounced back with a $5000 green day. I made another $5000 on Monday, and today, I was up $2000. At this point, I’ve recovered about 80% of what I lost in my drawdown. I’m ready to be a bit more aggressive going into the rest of the week, as I’m feeling more confident.

Reducing Share Size

After my fourth red day in a row, I decided to reduce my share size so I could only trade with a max of 10,000 shares. I think that was a good decision to help me stay reined in. Ultimately, that decision is what helped prevent me from having a multiweek drawdown. Usually, once I’ve recovered about half of my profit or half of my loss is when I start to size up, pull back the restrictions, and be a little bit more aggressive.  Since this drawdown only amounted to about $15,000 in total, after I’d made back $7500, I was starting to feel like I was back in the driver’s seat.

So now, let’s talk about what separates this drawdown from a trader who might go on a multi-week or multi-month drawdown. I have known many traders who have had many years of consistency but found themselves in the midst of back-to-back red months, very poor accuracy, emotionally fueled trading, and a substantial drawdown. These types of situations always begin with one or two red days, just like my latest drawdown. However, something happens here that makes it worse. Rather than enforce guardrails and boundaries to slow down the bleeding, they will get stubborn, frustrated, and emotionally hijacked. That leads them to trade even more aggressively in the face of loss. This is a human response. When something is being taken away, we reach for it, and we pull even harder to get it back. This response, however, is not conducive to success as a day trader.

Trade Smart, Not Hard

When gains become hard to capture, rather than trying harder, you want to try less. This means when the market is cold, you want to ease off the throttle and slow down, but the instinct is to double down to be even more aggressive. That’s because now, not only are you trying to make your daily goal, but you’re also trying to recoup what you previously lost, which means in a poor market. You’re now trying to make twice what you would make on average during a hot market. That’s gonna be pretty hard to do. The more days that go by where you’re falling short of this unrealistic goal, the more frustrated and emotionally compromised you become. I say all this from a place of being very empathetic to those who are in this position because I have been there myself. I know the pain that comes with experiencing a large loss. It’s important to note that a large loss is relative. What might be large to me could be astronomical to you. What could be large to you could be very small to someone else. It’s all relative. The point is that the pain is the same.

If we gauged your response just based on how much pain you have, you could be in as much pain from losing $100 as I might be in from losing $10,000. That pain and discomfort is what will then lead to impulsive trading. But, here’s the problem: if you get emotionally triggered when you’re down $5000, imagine what’s gonna happen when you go into a drawdown of $50,000 or $75,000. The more you lose, the deeper you fall into a state of emotional hijack. That’s why it is so important to do everything possible to preserve your emotional state. So, after having one or two or three red days in a row, you have to acknowledge that what you’re doing is not working. It doesn’t mean that your strategy doesn’t work. It doesn’t mean that you’re no longer a profitable trader. It just means, most likely, that there’s been a shift in the market that you’re trading, and it’s not conducive to your strategy right now.

So, the things I do when I’m faced with 23 or four red days in a row is I reduce my share size, and I begin doing a meditation before I start trading. And what I’m meditating on is being okay with the discomfort that I’m feeling at that moment, being okay with not taking any trades today, and being okay with focusing on the best quality setups, even if that means there’s only one or two of them this week. I will tell you that it is a struggle. On Tuesday morning, I told myself I was going to be calm, cool, and collected. The next thing you know, within a period of 12 seconds, I incurred a $5000 loss. It was instantaneous. For just a moment, I gave in to my emotional impulse to chase a stock and press that buy button. It flushed down, and I lost over a dollar a share. I lost my discipline in that moment. I came into the day with discipline, and then I suddenly stopped being disciplined, and that was on me. I should have been more disciplined.

The Dangers of Emotional Capitulation

One of the biggest dangers of falling into a multi-week and a multi-month drawdown is when you emotionally capitulate. Emotionally capitulating means you basically say, “screw it, I have nothing left to lose.” At that point, you’re taking tremendous amounts of risk, and you’re positioning yourself, unfortunately, to take catastrophic losses.  What will ultimately happen if you continue down that path is you will be faced with a trade that could blow up your account because your account keeps getting smaller and smaller and smaller until it’s finally gone. Now, once you’ve hit rock bottom, then there’s a whole different conversation about how you got there. A multi-month drawdown turns into an annual or a multiyear drawdown when a trader digs their heels in and refuses to acknowledge that what they’re doing is not working. I have watched traders make millions and millions of dollars only to lose it because they refused to adapt to a change in the market. It’s important to know when to walk away and when to take profit off the table. That is true on an intra-day basis, on a weekly basis, on an annual basis, and when it comes to your career as a trader. However, many people, when faced with loss, begin chasing the loss. They struggle with the sunk cost fallacy that because they already have so much invested, they feel they are justified in chasing those losses to try to recover.

Hitting Rock Bottom

Somebody recently asked me what my turning point was in my career. My turning point was when I hit rock bottom. I didn’t have to lose half a million dollars to hit rock bottom. I didn’t make 5 million and then lose 5 million. For me, rock bottom was accumulating $30,000 of credit card debt and spending 18 months trying to learn how to trade with nothing to show for it. I had made about $30,000, and then I lost it. In the meantime, I’d accumulated credit card debt by paying for my cost of living on a credit card instead of taking money out of my account. So every time I would lose money in my account, I was losing the ability to continue to trade. My turning point came after a final big loss that made it so I couldn’t trade in my account until I added more money. The reason this was a turning point was because it forced me to look very carefully at what I was doing that was working and what I was doing that was causing me so much trouble. Hitting rock bottom also forced me to come to the table with a sense of discipline that I didn’t have before. I knew that this was going to be my final chance to make it work and that I had to do everything the right way. I could not continue to give in to my emotional impulses. Had I not hit rock bottom, I think I would have likely continued to lose money if I had added more money to the account.

Necessity is the Mother of Invention

There’s a quote that “Necessity is the mother of invention.” In my case, I simply could not afford to make another mistake. I did a lot of interesting things during my period of recovering from those losses. I remember putting a tack on my shoe so I would feel uncomfortable while I was standing and trading. It helped remind me to walk away sooner, and, of course, I would take the tack out of my shoe once I was finished with trading. I couldn’t afford home heating oil since I was putting that money into my trading account, and I had to collect and split firewood to be able to keep the house warm through the winter. I spent my afternoons outdoors doing this type of manual labor instead of staring at the computer gambling during the hours of the market, where I generally lost money. Trading did not come naturally to me. I didn’t have much beginner’s luck, and I found myself easily giving in to the fear of missing out. So, for those who are in any of the phases of drawdown, I think it’s important to realize that to stop spiraling, you seriously need to stop doing what you’re doing right now in your trading. That requires having a very high level of discipline. The bigger the drawdown, the more discipline it requires.

You may only be able to sit in front of your computer without falling victim to FOMO for half an hour a day, but if that’s all you can manage, then you should just do the 30 minutes of trading and then come back and try again tomorrow. The last thing you wanna do is continue the downward spiral and the cycle of getting more and more aggressive to try to compensate for losses. I know from experience that that is a path to hitting rock bottom. It’s just not worth it. So, while being in a drawdown is never fun, the depth of your drawdown is within your control. No matter how deep in the red you are right now, you have a choice to take a step back. Look at what you’re doing that’s working, and look at what you’re doing that’s not working, and create a set of guard rails that you will follow to keep you on the track to recovery. In my new book, How To Day Trade: The Plain Truth, I lay out 20 guard rails that I’ve implemented in my trading that have helped me during periods of drawdown. I used these just this past week to help me recover and get back on track before I dug myself a multi-week or a multi-month drawdown. I encourage you guys to pick up a copy of the book and take a look at these guardrails.

Stay Social

Check out more articles written by Ross Cameron on Entrepreneur and don’t forget to check out his YouTube channel. To learn more about Ross, check out his biography on his website or TireKickers. In case you hadn’t heard, Ross Cameron turned $583 into over $10million day trading small cap stocks. You can read about it on Entrepreneur.

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Also, make sure to check out Ross’s brand new book, How To Day Trade: The Plain Truth!