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LOCATION: INDEX >> GUIDE >> Losing Streaks

Article: Losing Streaks (15 April 2006)

by Courtney Smith

by Courtney Smith


One of the toughest experiences for any trader, pro or amateur, is to go through a losing streak. Unfortunately, it is going to happen to every trader at some time. It may financially ruin you and psychologically break you. It may put out of the trading game forever.


Trust me, it will happen to you. It has happened to me.
How you deal with it will probably determine your eventual success as a trader.


One of my techniques for testing the success of a mechanical trading system is to use a Monte Carlo simulation. I take the price history of every futures contract that I want to test the system on and use statistics to describe that price series. I use the statistical description and a random number generator to create a price series for that commodity that is of infinite length.


I can then use that infinite price series to test mechanical systems. I can effectively test the system over, say, 100 years instead of just the recent past of the commodity.


What I found is that ALL trading systems will go broke eventually. There is always an amazing series of events that occurs that will cause every system to go broke. Conversely, ALL systems go through periods where they knock the ball out of the park. The point is that almost anything can happen over the long run. You WILL go through a losing streak if you trade long enough.


The first thing you will feel is doubt about yourself as a person and in your techniques. You will start to flinch when you put on a trade. You might start to not put on trades that you really should put on.


Here's what you need to do when dealing with a losing streak:
1. Move to a smaller bet size.
2. Examine the recent track record to ensure that it is within normal expectations.
3. Examine your psychology


Move to a smaller bet size


First, you need to cut the loses but still retain your self discipline. The way to do this is to continue to trade as your always have but to cut back on the size of your positions. For example, you may be trading 10 contracts normally. Now is the time to cut back to 5 or even 1 contracts while you examine the current situation.
This tactic will immediately cut your losses if the losing continues. You will have dramatically cut your losses if there is something wrong with your techniques. Don't forget the first rule of speculation: cut your losses and let your profits run.


Additionally, the psychological pressure will ease off as you are now trading for a peanut rather than a mound of money.


Second, you need to examine if the current track record is unexpected or expected. To do this, you need to keep track of your past track record and/or of the theoretical track record of your system. Is the current bad streak within the historical record?


If yes, then you simply must grit it out and ramp up your trading to normal or somewhat below normal levels. If things are normal then you must assume that your techniques are still working no matter how painful it feels to be losing money.


If the current losing streak is outside the historical record, then you have a real problem. Now you must brutally re-examine the basics of your technique. Are you doing something different than in the past? Did you add a new twist to your old techniques? Are market conditions different than in the past?


Obviously, the answer to these types of questions are critical. If you have changed the system, then switch back! If market conditions have changed, will they change back? If yes, then keep trading but at a low bet size. If not, then stop trading.


Presumably, you had been making money in the past. That means you had an edge in the market. Let me quote the CEO of John Henry & Co in their latest monthly newsletter (http://www.jwh.com/NewsLiterature.asp?CAT_ID=1 ). John Henry is one of the most successful and disciplined of the systems traders. They are currently going through a bad streak.


"Jake: What's a tough guy?
Michael: I don't know.
Jake: A guy with an edge. What makes him sing better than me? Something in here. What makes it loud? A microphone. That's his edge.
Michael: Edge?
Jake: A gun, a nightstick or a razor. Something the other guy ain't got. An extra reach on a punch, instead of brass knuckles, a stripe on a sleeve...a badge that says 'cop' on it, a rock in your hand...or a bankroll in your pocket. That's an edge, brother. Without an edge, there ain't no tough guy.
"Orson Welles could have been speaking about hedge funds, CTAs or managed futures - with that piece of dia- logue from 'The Lady from Shanghai'. We are no tough guy, yet when there is a period of poor performance, there could be the belief that a manager has lost his edge. We have not lost our edge because it is instilled in our behavior. Our edge is simple. We stick to our discipline and stay focused. Many times during a drawdown man- agers will switch models and style in order to capture the current market behavior. We stick with our systems and follow the trend. We know that there will be periods of choppy and sideways performance. It is part of market behavior and has to be minimized; however, we also believe that trends will be created by the natural ebb and flow of markets. We have made portfolio adjustments to account for changing correlations and market liquidity. We have also changed allocations across models in an attempt to minimize downside, but we have continued to maintain our quantitative style that depends on trends. It is not an edge based on believing that we are smarter than the rest of the market, but on the idea that focus will allow us to be placed in a position to attract the most out of market displacements when they do occur."
Mark S. Rzepczynski
Ph.D. President and Chief Investment Officer
John W. Henry and Co."


Mr. Rzepczynski makes a key point here that affects both your trading and your psychology of trading.


The key to not letting your psychology get affected is to not tie your ego into the trading performance. Instead, focus on this as a learning experience. Try to look at every trade and the current losing streak as an eduction. After all, your losing streak is just the tuition for you to become a better trader.


Stop thinking about the money you are losing and start thinking about what you are learning. The more you think about learning and the less you think about your ego or the money you are losing, the sooner you will get back to winning.


The bottom line is that everyone goes through losing streaks. Get used to it. The key is to retain your psychological equilibrium so that you can objectively examine your trading to make sure that it is sound or not sound.

RETURN

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