How to Preserve Your Sanity in Drawdowns

Preserve your sanity by implementing maximum levels of allowable losses per day, week, and month.

When they are hit, you stop trading for that period of time.

For example, if you set a daily loss on your equity of 2% and you lose that much on your overall positions, you go flat.

If you have a 8% rule on your overall equity for the month, you quit for the month even if it’s only the 21st of the month.

You can put a “haircut” in place as well. As you approach 5% for the month, you haircut your overall trading equity (what you base your positions on) by 20 or 30% so that your losses will be even smaller. That means if you start with 100% and you’re down to 95%, trade the rest of the period based upon 70% of your equity. This is done to soften the financial and emotional blow of your drawdowns.

Being down might not be much for you, but when you get to 10%+, these rules mean a great deal. If you systematize them before you start trading, you’ll be sticking to your model during the drawdown. You don’t want to stop trading because you don’t know when the winners are going to hit.

If you trade with protective stops in place (and you should), you can calculate how much of your equity you will lose if they all get hit.

You can do this with open trade equity and trailing stops also. It’s a very helpful process.

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