The Drawdown Mentality

The Drawdown Mentality

It's hard to come back when you're down. Trading is easier when you are ahead of the game. There's no pressure to make up losses. You feel free and creative, ready to take a risk. But when you have to work hard for an entire month, or longer, just to break even, you can feel a wide range of emotions, which in turn can make you do things you just don't want to do. Returning to profitability, however, requires that you don't react emotionally. Instead, you must diligently control risk, and make trade after trade slowly and methodically until you make back what you have lost.

People react differently to a severe string of losses. Many seasoned traders take it all in stride and keep plugging away until they turn things around. But other traders may take the situation personally. They may feel that they have done something wrong. They may feel like a failure. At that point, pessimism and denial may set in. They may not want to face the trouble they are in. It's easier to just retreat and forget your troubles. These negative emotions, though, may stifle their creativity and deplete the needed psychological energy to fight back and win. Although it's tempting to fall prey to pessimism, it's vital that you maintain a winning attitude. You must trust your abilities and believe that if you make a heroic effort, you can recover from a drawdown.

Another reaction to a severe drawdown is to seek out revenge, as if you are fighting an opponent. Although a revenge mentality can make you feel powerful, it can also make you feel that you are omnipotent. You may erroneously think that you have more control than you actually do and you may start taking unnecessary risks and trading impulsively. In most cases, fear resides at the core of a revenge mindset. It is difficult to accept a big loss that will take time and effort to recover from. To cope with the fear, you may start to fantasize about how you can make back losses: "If I make 10 big trades in the next week, I can make up for all my losses." Soon, you start to believe that you can actually do it. But if you do, you may be taking unnecessary risks, which can make matters even worse in the long run.

There's only one way to recover from a drawdown safely. You must carefully manage risk and use the most reliable methods possible to make back losses. It's difficult emotionally to handle it, though. You can't feel down, but at the same time, you can't feel overly optimistic in an attempt to unrealistically overcome a major setback. Instead, you must stay calm, determined, and rational. You must work at a steady pace until you make enough profits to break even.