Earlier in the week, I experienced a drawdown of 33%. Since then my trading has at least stabilised, growing by whopping zero percent in the remainder of the week. I am content with this because in the past, before I started this blog, losses would beget losses until I would feel so wounded and filled with self-loathing that I would be on the verge of being physically sick. It’s a horrid feeling. This time around, I feel my constitution has been more resilient in the face of adversity. I am going to try and work my way out of this drawdown with patience. It will take time, but I will try.
I am giving myself a score of 7 out 10 for following my road map this week, but it’s worth pointing out that the score for Friday feels like my first 10 out 10 day. Today, I planned my risk parameters before entering a trade, and when the position moved against me, I exited for very small profit. I felt strongly about what I was going to do before I opened the trade, and after I closed out the position I had no inclination to get back in to the action. This is important, because I traded purely based on what I thought was rational, as opposed to trading off my needs and wants.
Cutting losses and letting your profits run
With hindsight, the trade could have returned 4x the amount risked, because the price eventually moved in my direction, but that is not really of my concern. It does however, raise an interesting point about the adage of letting your profits run. Many traders say this is their greatest deficiency. In my opinion, however, the adage carries a large element of deceit, because we tend think about it with respect to those trades that got away from us (i.e. with the benefit of hindsight, after the fact). After the fact, we could also talk of the losing trades we never should have entered, the winners we never traded at all, and so on.
For the majority of successful traders, cutting losers and letting winners run is not ‘how’ they got successful per se, but it is almost a truism; that is, for many strategies it is the only way for them to be successful. It’s a bit like saying when bond prices go down, interest rates go up – they have to, because they are two sides of the same coin. When a strategy has a positive expectancy, merely amending it to allow winning trades to run higher isn’t necessarily the best approach, because it requires giving your trades more breathing room, and with this breathing room comes scope for your profit to be eaten in to. It’s about finding an optimal balance.
It is important to allow one’s trade ‘breath’ in accordance with the time horizon of the trader – for example, a day trader will have a much tighter stop loss than a global macro trader – but merely adding a trailing stop to a trade because the trade ‘might’ continue to run in your favour doesn’t quite add up. I do use a trailing stop at times, giving my trades a slight chance to run, but I don’t want to give up a healthy portion of my profit after I have identified a good trade, executed it, and watched it move to where I expected it to move. I’m not saying there isn’t a psychological bias that makes novice traders take profits too early (there is quite a bit of evidence for this phenomenon). I just think that at every stage in the price action we have to ask whether we would enter in to the trade or not. That decision really should not be influenced by whether you already have the trade on in the first place.