I reduced my risk per trade to 2% at the beginning of this week, and promptly experienced a 2% loss. The pain of this relatively small loss was perhaps the worst that I have ever experienced, and I realized that my risk tolerance had completely evaporated. I decided to shut down all systems until the end of the month. Subsequent to this decision, Cable Glider booked a 250 pip gain, and closed the week in positive territory, but I did not participate.
Each time I have experienced a significant drawdown with a duration longer than a couple of weeks, I have reduced my risk on my “next attempt” to trade with reasonable size. I used to think it was okay to be a gun-slinger…after all, my risk tolerance isn’t going to INCREASE as I get older, right?
Well, here’s how drawdowns affect me…drawdowns are like a game. The participant in the game (The Market) attempts to split a log (The Trader) with an ax. If the ax does not strike with sufficient speed and power, it will make no mark on the log. Such is the effect of a shallow drawdown that is quickly recovered. It leaves no permanent damage. What if the next drawdown is bigger? The ax strikes with more power, cutting into the wood and leaving an impression that cannot be fully undone. Now that the log has been damaged, subsequent hits with less power will damage it further. Such is the effect of a drawdown that deep and / or not quickly recovered. The trader’s risk tolerance is permanently decreased.
This story isn’t as cute as “life is like a box of chocolates”, but I think it describes my process well. By the way, if you’re trading full time, Termites (living expenses) are eating the log every day as well! Yikes!
Interestingly enough, recovering from the deep drawdown isn’t enough to repair the trader’s damaged mindset. I’ve gone through deep drawdowns and quick recoveries, and those are the times when I literally feel like I’ve dodged bullets…I’m happy to be alive, but deeply unnerved.
The only way that I know to break free of the pain of a drawdown is to do a true reality check and mental reset of goals and expectations. There’s a powerful video that was posted earlier this week. This IS what a blowup feels like. I’ve been there, but fortunately I have not blown up my account for years…systematic money management is the best tool that there is for avoiding this type of catastrophe.
I am in the process of mentally resetting my risk tolerance, goals, and expectations. Here’s the reality. I have not blown up my account. I have surrendered most of my profits. I have to let go of the past and realize that this is outcome is much better than a blowup, and perhaps the best that I could hope for. After all, what are the odds that I would ”learn my lesson” about risking too much after a substantial profit streak? Something slightly north of zero…
So right now I’m still trying to figure out what my new level of risk will be, and how I will distribute it to my two trading systems that are live…time goes by so slowly when there is no action. 
Well, once again I’ve sustained a drawdown in excess of 40%…at this point, the drawdown stands at 42.9%, and folks, I’ve made a decision. This level of risk that I use is ridiculous. I experience gut-wrenching highs and lows too frequently. I approached this full-time trading experiment as a stress-test of sorts. I wanted to see how much risk I could handle in an attempt to get rich quick or get busted. In the pit of this, my third 40%+ drawdown in the course of 11 months, I realize that the negative psychological effects of this roller coaster ride are cumulative. I am not better able to handle this drawdown than the previous one.
For the record, I’ve been a full time trader for 8 months. My lifetime profit from the Cable Glider systems at this point is $18,000. My monthly expenses are around $2000….so it would be fair to say that I have scraped by.
I am going in a new direction. Instead of seeing how much stress I can handle, I’m going to approach trading in a professional, low risk manner, and see how much risk is appropriate to support my two goals of more consistent growth of capital and the elimination of the gambler’s rush that is achieved by risking too much. I have always said that I wouldn’t let anybody trade with the amount of risk that I took with the Cable Glider, and now finally, I will not let myself do it either.
The immediate result of this decision is that I will be searching for alternative forms of income (employment!), since there is no chance of risking less, and earning a living, given my current level of capital.
I am more than a little disappointed that this experiment ended somewhat bitterly, but I look forword to the day that I am able to risk 1% of my capital per trade and earn enough to make a living. That day may be years away.
I think that lots of part time traders aspire to become full time traders. I am blessed to have had both experiences. Full time trading gives one a sense of independence and fulfillment, but it also make the trader more sensitive to the pressures of a drawdown. Perhaps successful part time discretionary traders will earn more by going full time, but I learned within one month of going full time myself that for me, systematic trading is not a full time job anyway. I actually only need to devote 10 hours a week to it, tops.
In the pit of a drawdown, it is hard not to feel like a failure. I told a close friend last night that I’m not broke, and I don’t want to be broke, so it’s time to start behaving more responsibly. I’m in the same financial position that I was 8 months ago, and yet I’ve learned an immeasurable amount about trading and about myself. The final model portfolio chart for this phase of my trading career will show a 143 % return over 15 months, which when I think about it, is still absolutely remarkable…given what I’ve already said about “scraping by” we can see the effects of undercapitalization and unfortunately timed additions and withdrawals of capital. The model portfolio represents what would happen if someone had invested $10,000 with me 15 months ago and didn’t add or remove capital…it’s true, you would have made 143%, but I think you might have fired me after the 41% drawdown last February, or the 50% drawdown last May, or the 42% drawdown today.
Finally, I am still a young man with a passion for developing and deploying mechanical systems. The Cable Glider should continue to serve me well in its new, low risk form, and I have no doubt that I will create better systems in the future. In short, the dream is not dead…the journey continues, and I am enjoying it.