TRADETHINK ARTICLES : Drawdown, What Separates the Successful from the Unsuccessful

February 13, 2009

Drawdown, What Separates the Successful from the Unsuccessful

By Chris Morse

There are fewer things more important in trading than one's ability to stick with things when the weather gets foul. In trend trading we are waiting patiently for the next big moves. The markets only trend about 30% of the time. The rest of the time markets are going sideways or are in a consolidation mode.

During periods of choppy markets we will inevitably see and feel drawdown in our trading portfolios. In order for the markets to march on toward the pivotal new trends, we must first see complacency and indecision played out in the marketplace. It is when the markets are taking their breather and gathering up steam that trading strategies will get beaten up a bit by the entering and exiting of markets without any significant moves.

It is only after sufficient turmoil and series of losing trades that the markets become enabled and set up for us to witness what can at time only be described as magical. For the markets must go through at times what can be considered tremendous periods of drawdown.

Drawdown truly is by this writers account a tremendous trading opportunity. There are perhaps 2-3 periods of drawdown each year which can last for weeks or even months in duration. It is only after the drawdown ends that the draw up can begin. Draw up is the 30% of the time that trend traders live for. However, to participate in the next draw up on must invariably suffer to an extent the drawdown that is the precursor for the draw up.

It is said that the best time to start trading a system such as the one I developed called TradeThink, is when the system is in a drawdown. Opportunities for trading are found during times of drawdown. Some say it is best to wait until after a drawdown finishes before starting trading. Theoretically starting to trade after a drawdown is the best time to start trading. Unfortunately there is no way to tell when a drawdown has ended until a new draw up has begun. After the new draw up starts it is too late to participate in all of the next moves.

Draw ups are typically quite violent and come on the heels of periods of serious trading pain. I truly believe one of the great differences between successful and unsuccessful traders is one's ability to cope with drawdown.

Let me illustrate to you through my own system TradeThink how drawdown is a great opportunity to begin trading. You may have to go through some pain to get to the big trades, but as they say "no pain, no gain."

Below are several examples of big trades that could have gone through significant drawdown before making that big move.

Corn

The TradeThink trading system signaled three times in September 2008 to Short (Sell) the Corn futures.

As a result of the three losers in Corn the system was down a total of $3,900. Had you quite trading you would only have your loss.

At the end of September TradeThink was rewarded with a huge trade.

Had you stuck through the initial drawdown you now got the payday with a Corn trade that moved down $1.83 or $9,150 per contract. Even after subtracting the losers of $3,900 from the winners of $9,150 = $5,250 profit.

British Pound

The TradeThink trading system signaled four times from May 2008 - July 2008 to Short (Sell) or go Long (Buy) British Pound futures.

As a result of the four losers in the British Pound the system was down a total of $3,550. Had you quite trading you would only have your loss.

At the beginning of August 2008 TradeThink was rewarded with a huge trade.

Had you stuck through the initial drawdown you now got the payday with a British Pound trade that moved down 1591 pips or $9,943.75 per contract. Even after subtracting the losers of $3,550 from the winners of $9,943.75 = $6,393.75 profit.

Coffee

The TradeThink trading system signaled four times from June 2008 - August 2008 to Short (Sell) or go Long (Buy) Coffee futures.

As a result of the four losers in the Coffee the system was down a total of $5,200. Had you quite trading you would only have your loss.

At the beginning of September 2008 TradeThink was rewarded with a huge trade.

Had you stuck through the initial drawdown you now got the payday with a Coffee trade that moved down 33.5 cents or $12,562.50 per contract. Even after subtracting the losers of $5,200 from the winners of $12,262.50 = $7,362.50 profit.

Cotton

The TradeThink trading system signaled four times from May 2008 - August 2008 to Short (Sell) or go Long (Buy) Cotton futures.

As a result of the four losers in the Cotton the system was down a total of $1,320. Had you quite trading you would only have your loss.

At the beginning of September 2008 TradeThink was rewarded with a huge trade.

Had you stuck through the initial drawdown you now got the payday with a Cotton trade that moved down 23.98 or $11,990 per contract. Even after subtracting the losers of $1,320 from the winners of $11,990 = $10,670 profit.

Heating Oil

The TradeThink trading system signaled nine times from August 2008 - September 2008 to Short (Sell) Heating Oil futures.

As a result of the nine losers in the Heating Oil the system was down a total of $12,500. Had you quite trading you would only have your loss.

At the beginning of October 2008 TradeThink was rewarded with it's first of two huge trades in Heating Oil.

Had you stuck through the initial drawdown you now got the payday with a Heating Oil trade that moved down 51.26 cents or $21,529.20 per contract. Even after subtracting the losers of $12,500 from the winners of $21,529.20 = $9,029.20 profit.

Then Heating Oil was given a second huge move. Which goes to show that is is not prudent to exit markets after a big trade.

Now had you stuck through the initial drawdown and ridden the next winner, you got another big trade for 4154 or $17,446.80 per contract.

The system showed $26,470 in total drawdown before being rewarded with moves totaling $70,059.75 per contract. That is $43,589.75, not too shabby for having some discipline and sticking through the drawdowns.

About the Author

Chris Morse is the Developer of the TradeThink trading system. He has been involved in the development of trading strategies for nearly ten years. Mr. Morse developed a very robust system which is now in private use at one of the largest FCM's and has earned sizable returns for the last 3 years. Mr. Morse now focuses his time exclusively on developing and managing his systems.

Disclosure: Commodity trading has large potential rewards, but also large potential risks. You must be aware of the risks and be willing to accept them in order to invest in the futures markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to buy/sell commodity interests.

Notice: Returns are hypothetical. Hypothetical or simulated performance returns have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since trades have not actually been executed, the results may have under or over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight, no representation is being made that any account will or is likely to achieve profits or losses similar to those shown.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. INVESTMENTS IN FUTURES INVOLVES HIGH RISKS AND YOU CAN LOSE A LOT OF MONEY.

FUTURES TRADING HAS LARGE RISKS. YOU MUST BE AWARE OF THE RISKS AND BE WILLING TO ACCEPT THEM IN ORDER TO INVEST IN THE FUTURES MARKETS. DON'T TRADE WITH MONEY YOU CAN'T AFFORD TO LOSE. YOU SHOULD CAREFULLY CONSIDER WHETHER YOUR FINANCIAL CONDITION PERMITS YOU TO PARTICIPATE IN THE FUTURES INDUSTRY. IN SO DOING, YOU SHOULD BE AWARE THAT TRADING FUTURES AND OPTIONS ON FUTURES CAN QUICKLY LEAD TO LARGE LOSSES AS WELL AS GAINS. SUCH TRADING LOSSES CAN SHARPLY REDUCE THE VALUE OF YOUR ACCOUNT. THIS IS NEITHER A SOLICITATION NOR AN OFFER TO BUY OR SELL FUTURES INTERESTS.

USERS OF THE SOFTWARE ARE SOLELY RESPONSIBLE FOR THE OPERATION OF THE SOFTWARE. TRADE POSTINGS TO THIS WEBSITE ARE EITHER ONLY EXAMPLES OF HOW THE SOFTWARE WORKS OR THE RESULTS OF OPERATION OF THE SOFTWARE AFTER THE MARKET CLOSES. THIS IS PROVIDED TO LICENSEES OF THE SOFTWARE ONLY TO HELP VALIDATE THEIR OPERATION OF THE SOFTWARE. TRADE THINK DOES NOT MANAGE ANY MONEY OR PROVIDE TRADE OR INVESTMENT RECOMMENDATIONS. PROSPECTIVE TRADE THINK CUSTOMERS ARE ADVISED TO MAKE DECISIONS BASED UPON THEIR SPECIFIC CIRCUMSTANCES AND NOT MERELY ON THE INFORMATION CONTAINED ON THIS WEBSITE. THIS BRIEF RISK DISCLOSURE STATEMENT CANNOT DISCLOSE ALL THE RISKS AND OTHER FACTORS NECESSARY TO EVALUATE YOUR PARTICIPATION IN THE FUTURES INDUSTRY, WHICH SHOULD BE CONDUCTED INDEPENDENTLY BY YOU WITH THE EXPERTS OF YOUR CHOICE.

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ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

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