Most traders realize that a strategy has winning periods in which the strategy does very well and losing periods known as draw downs in which the strategy gives back a few of the money it acquired. This reoccurring cycle of profit periods and draw lower periods is really because every strategy is built to take advantage of certain market patterns and/or market modes. For instance if your strategy is built to take advantage of an even upward trend, then that strategy is going to do very well during smooth upward trend periods. However if you simply trade that strategy throughout a different market mode than it had been created for, like throughout a choppy market, then your strategy are experiencing a draw lower period.
Traders intellectually know these profit periods and draw lower periods occur, however in practice their feelings obstruct of seeing these reoccurring cycles for what they’re. I’ve come across traders effectively trade an automatic technique for multiple several weeks, however the process has five losses consecutively plus they quit trading it. They are saying the process is all of a sudden damaged or a variety of other rationalizations to warrant why they stopped trading a method which was employed by all of them with good results. All sorts of different mental barriers show up for traders once they enter a draw lower period. Many traders come with an excessively active risk aversion which risk aversion causes doubts and negative mental chatter which makes it hard to concentrate. The end result is most traders haven’t developed any rules for which they ought to do throughout a draw lower period. Given that they aren’t sure the things they must do, their mind chatter takes hold plus they make emotion based knee jerk trading decisions.
I suggest that each trader have rules about draw lower periods including when you should trade so when to not trade a strategy. One idea I’ve found useful would be to really monitor the equity curve on every trading chart to provide a 3rd party objective take on the strategy’s performance. I am not speaking concerning the cost action around the chart I’m speaking concerning the actual equity curve from the trading profit. Once the equity curve is booming, that’s when you be trading your strategy. Once the equity curve is shedding, that’s when you paper trade that strategy.
Every strategy experiences cycles of equity run-ups and equity draw downs. When periods of equity draw downs happen, it does not imply that there’s a problem using the strategy. When you trade a particular strategy depends upon what market mode that strategy was created to benefit from. Once the strategy design is within sync using the market mode that’s the time when that strategy will make money. Once the strategy design isn’t synchronized using the market mode that’s the time once the strategy will hand back money. This is actually the nature of automated trading strategies. If you are planning to trade an automatic strategy you must realise these reoccurring cycles and also have rules that will help you manage them.
Understanding these cycles can help you realise why there’s no such factor like a “ultimate goal” trading strategy. Traders constantly look for this mythical strategy which has a remarkably high number of winners rather than has any draw lower periods. No such strategy exists. If you discover a method which has a through the roof number of winners, more often than not that strategy comes with an inverted risk reward ratio. What this means is the process employed a bad risk approach and therefore the danger is simply too high with this to become a good technique to trade. This method literally has inverted the golden rule of trading.
Let us get practical about the best way to implement an effective rule to deal with draw lower periods. First, to recognize when you’re entering a drawdown period let us make use of a fast paced average and slow moving average according to your equity curve (this is not on cost). Once the fast equity curve line moves underneath the slow equity curve line, this is actually the signal to paper trade that strategy. Once the fast equity curve line moves over the slow equity curve line, this is actually the signal to begin live trading that strategy. Now you must a properly defined rule to recognize draw lower periods and how to correctly manage your trading to reduce your draw lower losses.
Trading your equity curve is much like getting a goal 3rd party monitoring each trading chart to let you know when you should live trade versus. when you should paper trade. You are able to eliminate one a lot of emotional stresses in trading using the equity tracing concept to manage your draw lower period losses.