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Drawdown Wisdom

In the early 1990s, Commodities Corporation (a famed trading incubator that taught and bankrolled new traders) invited a group of Japanese traders to its company for in-house training. One up-and-coming trader at Commodities Corporation took his new friends to lunch. He told his guests how important risk management was, and to risk only 1 percent per trade. He was clear that experiencing small losses were part of his process to ultimately finding big winners. The Japanese traders, with puzzled looks on their faces, asked, “You have losses?” Ouch! Time for everyone regardless of country to learn about small losses, and to love them, even if that means your account will occasionally have drawdowns. What are drawdowns? Drawdowns are those non-fun time periods where your small losses add up to reduce your account size. They happen. The key is to quickly and successfully recover from them by sticking with your trend trading system and waiting patiently for big trends to reappear, which let you get back to making new money again (and paying for all of those small losses). How much can you lose? That’s an important question to answer, and it comes down to the risk you take (which will vary by your personal choice). However, trend following is much easier to believe in when you consider the length of professional trend trading track records, especially the really long track records that offer proof of viability. That said, some will spend a lifetime trying to avoid any loss (even though that is impossible).

Rough Patches… Just Part of the Game

Dry spells and rough patches are all part of this trend game. Sometimes it can feel like you are all alone in your drawdowns. It’s always good to be reminded that many, many people have been there before and made it out on the other end. Consider some feedback:

Nice podcast with Mark Minervini and was pleasantly surprised. Did not know what to expect as I don’t know much about [him]. You guys both brought home some really good points. Points that especially were practical and informative. The nice thing with the podcast is that at times you might be going through something in your trading and one of your guests makes a remark or reference and you have one of these eye opening moments. I guess in my own little way I feel a sense of validation!


Diversification is Key to Trend Following


Hey Mike, I was thinking about your recent podcast where you talked about how the sharks were posting Bill Dunn’s worst years to demonstrate the failure of trading. It reminded me of the recent articles on John Paulson. You may have read that his gold fund is doing horribly this year. Down 65%. Just like with Bill Dunn, people who don’t understand trading are just salivating over this demonstration of the “failure of trading”. The fund only represents 2% of Paulson’s funds. If this fund operates totally independently of his others funds then I might be inclined to agree with some of the criticism Mike. I can’t understand how any professional trader of Paulson’s caliber could allow his fund to lose 65% of assets. Also, I can’t understand why any professional trader could have looked at a gold chart for the past few years and decide to go long which is the only way that I can imagine that he could be down 65%. If he does incorporate counter trending strategies and was long then I don’t understand why his stops didn’t prevent such a massive loss. On the other hand Mike, if this fund does not operate totally independent, but operates as part of all of his assets, then my view would be totally different. A 2% investment of total funds under management while a bit high, is not a totally unreasonable amount for a professional to risk on a trade. Furthermore if that is the case, just think about it Mike. A 65% unrealized loss on a particular trade means you’re still in the trade. We are actually willing to risk 100% of the 1% or so that we risk on each trade. I don’t think some people realize that. If you have $100,000 trading account and you risk $1000, 65% down in that trade means you are still in the trade. The trade doesn’t end until you either get stopped at a 100% loss of the $1,000 or you take profits of 2:1 or 3:1 on that trade. Some people don’t seem to realize that about trading.

Confusion here.

65% loss on one market is not trend following! Where is the cutting of loss? Dunn’s drawdown was from taking many small losses across many markets. They add up. No one drop on one market. Plus there really can’t be a trend following fund on one market alone. That means no diversification and that is a recipe for failure.

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