A drawdown is a decrease in investment. A decrease is a loss. Drawdown management is loss management.

Everyone who takes trading as a serious profession should take capital usage seriously. No one is capable of winning all the time, nor anyone is capable of clairvoyance or the future. Contradictory uncertainty is one of the enduring inherent characteristics of financial markets that anyone with a career can learn, or learn through experience, most of which is traumatic. mentality. This shows that the core mindset of thinking should be the priority of risk, not profit. It also means that, if you cannot ACCEPT losses and CONTROL losses, you cannot trade as a profession.

The above statement leads to 2 problems: How to accept losses, and how to control losses.

There is an obvious fact supported by the laws of statistical probability that every trading system cannot avoid losses. Despite the problems of trading psychology and discipline, LOSS ACTION is the design of a capital management system so that it is able to withstand as many losses as possible, with lower losses. as low as possible.

Take the example of a capital management system that uses 10% of the total account after each order


Example 1: Risk = 10%

Visible in this example, after a series of 8 consecutive losses, the Absolute Equity Drawdown reached $ 5217, or Relative Drawdown reached 52.17%, a huge number and certainly too psychologically unbearable as well the technology of any person, no matter how much experience it is.

A lot of people give up after being beaten up by reality like that. The few who stay will try to learn trading methods, capital management ... to design a way to survive.

Before continuing, let's go back to your transaction history. Study your transaction report to see how many consecutive positions your longest losing streak is. If you have never had a losing streak of 8 - 10 consecutive trades in a history of 3,000 or more trades, or you are the luckiest person in the world, and I highly recommend you try your luck with Lottery; or your trading system is one of the tops in the world. Anyway congratulations.

But if you've gone through a streak of 8 or more consecutive losses, calm down.

Reality shows that for a trader, 8 orders are not many. A scalper can place dozens of orders per day. A swing trader can also place twelve dozen orders per week.

8 orders and 10% per order, you lose more than half of your account. Apart from thirsty gamblers, no sane mind could withstand such a large drop. That is the first reason that reminds newcomers never to let themselves be "overexposed" on the market if they want to go the long haul. That is also the reason to remind you not to use the casino-style capital management methods like Martingale if you do not want to lose precious capital, you must spend the intellectual effort to win from the hands of the market.

When you lose a loss, the first reaction that comes to your mind is to make up for the loss. That is the spontaneous psychological mechanism built into the subconscious of each person from primitive times. However, when you have lost half of your account, you must assume the responsibility of doubling your remaining capital to return to your original capital. Your growth should now be 100%.

Warren Buffett at his peak also mentioned only 30% a year. That means even the brilliant Warren Buffett takes nearly 3 years to be able to double any amount. Can you do it? If not, lower your exposure level.

Continuing to examine the second example, this time the system uses 5% of the total account per order.


Example 2: Risk = 5%

Learn from the previous example, this time you cut your risk capital in half. You bear 5% of the risk. Better than the previous example, this time with a streak of 8 losses in a row, your Absolute Equity Drawdown is at $ 3017, and the Relative Drawdown drops to around 30.17%. This means that after a series of 8 consecutive losses and a 5% risk of each position, you have 2/3 of your account to continue fighting.

Not bad, especially when compared to the first person.

But not good enough, because if your losing streak is not 8 orders but 10, 12, 14, 16, or 18 orders, then you don't have any capital left. As mentioned, it is possible for a swing trader to place up to several dozen orders a week. With this example, your account will burn out in just a bad week.

Continue to example 3. This time you follow the advice of almost all experienced traders and use only 2% of your account for each order.


Example 3: Risk = 2%

Easy to see with this example, the trader spent $ 1319, or 13.19% Equity after 8 consecutive losing orders. Most traders accept this 2% risk, as it balances losses and returns.

But see the next example.


Example 4, Risk =?

In this last example, something happened in the mentality of the trader causing him to re-plan his risk level. After a series of 8 consecutive losing orders, his account dropped only $ 538, representing 5.38% of the total account.

When placing examples 3 and 4 side by side, you will see that on the 3rd loss order, the Equity level does not change much ($ 9604 and $ 9702), but the difference lies at the end of the losing streak. After 8 consecutive losing trades, the person in example 3 lost $ 1319, while the person in example 4 lost only $ 538.

What makes the 4th trader different from the 3rd trader?

At first, he admits he's not perfect. And he plans to prepare for his imperfections. Not only ACCEPT loss, but he also manages it.

With his first losing trade, he notes it. Then he cut the risk in half. With the second position, he risked only 1% of the total account, not 2% as before.

In this order, he continues to lose money, and he continues to cut his risk down to 0.5%.

With the third position continuing to lose money, he only lost $ 50 on total capital of $ 9702. A loss he was sure his account could afford if his trading strategy continued to malfunction. He decides to keep the risk at 5% until his system is working properly again.


Compare example 3 and example 4

Suppose if trader 3 and trader 4 use the same trading strategy (like a breakout), after a series of 17 consecutive losing orders (for example when prices go chopping sideways long and false breaks continuously. for example), trader 3 has lost more than a quarter of his total account, while trader 4 has lost only 1/10.

With such drawdown management, trader 4 is able to endure a chain of 24 losses to losing 12.67%, while trader 3 is only able to withstand 8 consecutive losing orders before his drawdown hits the threshold. 13%. Trader 4 is 3 times more able to withstand the attack than trader 3.

In other words, trader 4 has a 3 times more chance of survival than trader 3.

That is not to mention that the chain of losing 24 consecutive orders is extremely rare.

After planning well the part you allow to lose every time you are wrong, the next job is to get back to the starting line of 2% risk when you are right.


Going back to example 4 ...

Going back to example 4, when this trader suffered a series of five consecutive losing orders, his risk capital was reduced to only 0.5% per order (gray line).

This trader will only return 2% until his total profit is greater than 50% of the drawdown of the first order.

Keep the RISK percentage of an order LOW until you make TOO MORE of the money lost on your first losing trade.

For example with trader 4,
  • 50% of the drawdown on the first loss = 50% * $ 200 = $ 100
  • $ 9604 + $ 100 = $ 9704
So he is only allowed to return to 2% until he earns $ 9704, otherwise, he will remain at 0.5%. The reason is that until his trading system is able to return stable returns, we must assume it is in a long-term loss state.

And of course, if you can't ever get back to 2%, then you have to re-examine the trading system; with the assumption that you are a perfectly disciplined and perfected physicist. Naturally, no one is as profitable as a bad trading system. That is why you have to perform an extremely detailed system test (However that is not the purpose of this article.