There's no way of getting around it: losing sucks.
It's one thing to watch your favorite team lose a big game (like I did last Saturday night). That can be heartbreaking. Watching your favorite team lose can ruin a weekend.
Losing money is much, much worse.
When you lose money, it doesn't ruin a weekend, it ruins your trading account. When you lose money, it isn't a matter of bouncing back for the next game. It's a matter of maybe having to get a second job.
When you lose money, the stakes are a lot higher.
So when a trading system or a trading robot loses a trade, the reactions can be fierce. Depression can set in. Fear can set in. Extreme low quality of life can set in.
And who wants to deal with that?
We're programmed to seek pleasure and avoid pain. Everything we do can be traced back to one of those two things. So when we lose a trade, what's our natural reaction? To avoid that pain.
In other words, we stop playing the game. No matter how tough we thought we were, when the pain comes, we quit. Even though we would have won in the long run.
But what if the pain never comes? Or what if it comes very infrequently? Or what if the pain comes in a package that is much easier to handle?
Would that keep us in the game? Perhaps.
Is there a system that trades this way? Of course.
A while ago, we talked about a 100% system. As you recall, that doesn't mean you win 100% of your trades. It means you win 100% of your series of trades.
For example, you take a trade with your "100%-style" system, and you take profit. That's a win. No problems there.
Or you take a trade and it goes against you. Then you take another trade. And possibly another. After waiting for a certain period of time, eventually the sum total of ALL your trades turns positive. Another win. And so it goes.
This is not a new thing. Traders have been trading this way since trading was born. What's more, this is probably the easiest sort of trading system to create.
As my friend, Rob Booker, has talked about many times, this type of system can be anything. All you have to do is pick a random entry using any set of rules you like and pick a reasonable profit target. Then enter the trade without a stop loss. If the trade goes against you, get in again. If it still goes against you, get in again. And then wait to get back to break-even or into profit. Then close the trades.
This style of trading works. It's guaranteed to work. They say there's no guarantees, but there are. Trade this way and you'll make money almost all the time, possibly for months and months.
The problem is the rare time it goes bad. When this style goes bad, it can REALLY go bad. That's the conundrum. You can trade the most random, untested system ever, using any trade size you like, and you can potentially make truckloads of money for a long period of time.
But the drawdown will come. And it won't come just for a small slice of your money, it will come for the whole ball of wax. And if you're not ready for it, drawdown wins. When it does, game over.
There are ways around that, though.
What if you picked a trading system that puts you in a better position to have less drawdown? A random, sparsely researched system will win trades, no doubt about it. But a random, sparsely researched system will also get into trouble much more often and with much more severity.
It just makes sense. Let's say you do a bunch of research and come up with a trading system that only goes Long in the stock market when the Dow Jones drops 20% or more in a single day. Then you incorporate a reasonable profit target and no stop loss to round out your system.
On 10/19/87, you would have gotten a trade. If you entered on the close of that daily bar, you would have been profitable the very next day and every day after that all the way through today (November, 2016). Or you could have entered exactly when the market was down 20% and had the same results.
Whichever way you entered, as long as you didn't have a stop loss, you would have been profitable every day of your life since October 19, 1987 (if you had held on to that trade all this time). And the drawdown would have been minimal and not even twenty-four hours long.
Or you could have taken a reasonable profit, maybe a 5% gain, and been done. That's a 100% success rate with mild drawdown, and you never had to get out of trouble.
A random system won't produce that kind of result. Try it for yourself.
In short, a great way to minimize drawdown is to trade a system that makes sense (buying when people are freaked out) and has historically proven to stay out of drawdown.
The other way to minimize drawdown is to use a small trade size. When the drawdown comes, a small trade size armors you against the damage. A 500 pip drop at $1 per pip is only $500. On a $5,000 account, that can be handled pretty easily.
But a 500 pip drop while trading at $10 per pip is a $5,000 drawdown. On a $5,000 account, that's big trouble.
Same trade, same drawdown, completely different result. One is a blip. The other is a margin call. And it's all based on trade size.
Combining those ideas, if you use a system that reduces drawdown better than a random entries and you use a small trade size, you've got a chance to get winner after winner and not get knocked out by the drawdown.
That's a pretty good deal.
So what's the problem?
Not enough money.
Circling back to our Dow Jones example, if that was our trading system, we only would have had one trade since the 1980's. Yes, we won 100% of our trades, but we only took that one trade! We never lost, but we also don't have enough money.
That's the tricky part. Winning keeps us in the game, and that's crucial. But can we make enough money while we're winning?
Of course we can! Tune in to the webinar tomorrow to find out how.