I’m currently reading The Little Book of Trading by Michael Covel. It’s an excellent book for traders of all experience levels. It combines the vast and practical research Covel has become known for with extensive advice from some of the world’s most successful traders.
One passage that stood out to me makes a point that all traders – especially those new to the game – need to come to terms with.
“As a trader, you always want to prevent drawdowns from occurring, but trying to avoid them completely is absurd. In fact, it’s not volatile trading that you should be scared of; rather it’s trading that promises to make you money every month. That’s the strategy where you wake up one day broke.”
We’ve all seen those ads promising to show you how to take something like $1,000 a day out of the stock market. They promise you can do this each and every day. There’s nothing to it, they claim; just consistent profits and no volatility.
These ads are obviously enticing. Who wouldn’t want to robotically bank a tidy profit each day without ever having to worry about those pesky drawdowns?
But I can assure that the only people getting rich with these strategies are the people selling you these so-called “trading systems.”
The truth is, it’s absolutely absurd to think you can be a successful trader without ever having to experience a drawdown.
If you expect your trading account to go in a straight line all the way up to the top of the pyramid, without ever experiencing a losing month, then there’s a guy named Bernie Madoff who will happily invest your money for you.
If you want to be a successful trader, get serious about the realities of the profession.
Drawdowns are part of the game. Your job is to make sure these drawdowns occur almost entirely with your profits – and therefore affect your starting capital as little as possible.
I’ve noticed that a lot of newbie traders tend to jump around from one system to the next. (I’m certainly guilty of doing this in my early days of trading.)
They start with a proven system and find that it works pretty well. They put more money into the system and then experience their first monthly drawdown. This first drawdown is completely normal, of course, but it’s enough to send our new trader in search of a new system. One that promises to never have a losing month, week, or day! The results are always disappointing and costly.
As a trader, we all want to make as much money as possible. But we also want to be realistic with how we expect to make all that money.
Don’t get rattled by a drawdown; it’s part of the game. Instead, learn to manage these drawdowns as you accumulate your wealth in the long run.
Be an optimistic thinker, for sure. But don’t be an absurd thinker.
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