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c14 JWBK182-McDowell April 25, 2008 16:23 Printer: Yet to come
142 A TRADER’S MONEY MANAGEMENT SYSTEMHOW WILL YOU HANDLE DRAWDOWN?Drawdowncan affect both your trading psychology and your financial bot-
tom line. Knowing yourself and how to approach periods of stop-outs and
losses before they happen can enable you to lessen the negative effects.
Following are some rules and ideas to start with. You may have many of
your own rules and ideas that work for you; add them here as well: Ask the following questions on this checklist to analyze the drawdown:
Is this drawdown due to normal system probabilities?
Is this drawdown due to pilot error? Were there mistakes made, and
what were they?
How can mistakes be avoided or reduced going forward?
Were all trading system rules followed?
Did you set a stop-loss exit prior to entering the trade?
Did you honor that stop-loss exit, or did you hesitate or delay?
Do any of the trading rules need to be adjusted going forward to
reduce drawdown?
What is the percent of loss in the account?
Is this percent loss consistent with previous periods of drawdown?
What is the dollar amount of the loss in the account?
How many consecutive stop outs were incurred?
Other questions:
When drawdown hits 10 percent of account value, reduce trade size
and risk amount on each trade (refer to risk-of-ruin tables or use opti-
malfformula).
When there are seven stop-outs in a row, reduce trade size and risk
amount on each trade going forward (refer to risk-of-ruin tables or use
the optimalfformula).
When drawdown hits 15 percent of account value, stop live trading and
begin paper trading until profitable again. Identify areas for improve-
ment in prior trading and money management plans.
When a lot of 25 consecutive trades produce a loss for that period,
stop live trading and begin paper trading until profitable again. Identify
areas for improvement in prior plans.
Other:
Other:One important note about drawdown is that if after you paper trade
and generate a paper profit you go into the live market and lose money, this
means you have to work on your trading psychology. If you can generate
profits in a practice environment but lose money in the live market your