In this episode of Truth About FX, Walter breaks down some of the stickiest situation every trader (whether you’re a noob or a pro) should be prepared for… And how to have the right mindset to get past them. He shares a “special email” from a friend and how you can benefit from this.
Download (Duration: 08:42 / 9.95 MB)
In This Episode:
00:31 – the biggest one
02:06 – wiped out
04:03 – real approach
07:14 – call an ambulance
08:05 – funky market
Announcer: Sometimes, forex trading is a wild and wooly place to be. That’s why Hugh is here, to post your questions to Walter, the naked forex guy. Hugh’s got questions and Walter’s got the answers. Here at the Truth About FX Podcast.
Hugh: Hi, Walter. What are some of the situations that traders should be mentally prepared for before the situations happen?
Walter: What a great question. The biggest one is that you’re going to have a drawdown. It’s going to suck and you’re going to have to figure out a way to get out of it. That’s the biggest one.
Mentally, also making mistakes. You’re going to make mistakes whether it’s in execution, or somewhere along the line you miscalculated your risk or you chose the wrong broker.
Somewhere along the line, you made a mistake and you’ve got to deal with that too, as a trader. But, the biggest one and the number one thing that I believe separate those traders who make a living from this versus those traders who really struggle is that the traders who do well are able to pull themselves up out of the drawdown.
I mean, it’s as simple as that and it sounds crazy that, of course, I can withstand a 35% drawdown but it’s so true that people freak out. They do their backtesting and they go, “Oh, okay”.
For example, I’ve got an email here from a guy yesterday and he said… He was saying that he did a backtest. He tested a system that we we’re talking about and I was sharing with him.
My friend, he messaged me in the forum and he said… He quoted this thing up and it’s for the H4 GBP/AUD and he found that it turned a $100,000 into $2 Million in two years. That’s the system that he traded, that he tested, which is great but then in the next two years, it completely wiped out the account.
Here is the thing, this is what you’re dealing with. You’re dealing with risk. The things that you need to be mentally prepared for are dealing with the risk issues. That really comes down to drawdowns.
You have to mentally prepare yourself for the drawdown that is going to occur and that you will be able to pull yourself up out of. You can do it. It’s possible. It might seem like it’s crazy and if you do crazy things, it will be difficult to get out of.
Like, if you’re in a 10% drawdown and you start taking twice the risk to get out of it or if you start Martingale trading or whatever, that’s where the problem is. The biggest thing you need to have is a plan.
What am I going to do when I hit my drawdown? First of all, you want to know what’s the drawdown that you’re trying to avoid. Maybe it’s 15%, maybe it’s 20%, whatever that number is, then you backwards engineer your risk based on that.
I talked about the risk calculator, it’s linked up in the shownotes for this episodes. Obviously, you want to use that and figure out how you can avoid that drawdown. How you make it really, really unlikely that statistically, you’re going to hit that drawdown and then you trade that way.
When you do hit that really bad drawdown, you activate your plan. Let’s say you’re max drawdown is 15%, so when you hit a 10% drawdown maybe something kicks in. Maybe you don’t trade for two weeks, maybe you just backtest and reaffirm that what you’re doing is correct. Maybe you look over your trades and make sure they’ve been executed the right way or have they been getting sloppy. These are the sorts of things that you need to put into place and sort of your plan to deal with drawdowns.
The best traders do this and they’re ready. They know when the drawdown comes, they’re going to get out and do. But, if you end up in a drawdown and change your system or change your approach, your timeframe or whatever, that’s where it gets tricky because maybe that system didn’t jive with you.
Maybe it wasn’t the right system for you. That’s fine but the real approach to trading is to have a plan, to know what to do. For me, if I get to that point where I’m almost to my max drawdown, I boom! Stop trading immediately. That’s it, done.
I would’ve go back and I would want to look at my trades: “Am I doing something wrong? Am I executing as I should?” Also, I would want to load new data into forex tester and retest my system, make sure that it’s been doing what I expected it to do. Let’s say, for example, I’m trading a system live and I’ve been trading it for two years and, then all of a sudden, I’d get really close to my max 15% drawdown.
I’m at 11% drawdown so then I’ll go back and I’ll load in the last two years and make sure, “Am I still doing this the right way? Is there one particular market that’s causing this really poor trades?,” because that could be it, right?
It could be the system works. It’s just one pair that is not really volatile of something and it’s really messing with the results. It could be that I’m getting sloppy or doing something weird. It could be that my broker is trying to slip me because I’m making money and they don’t like that.
Whatever it is, have a look at that but the biggest thing is to take a break. That is how I approach it but everyone has a different way to do that but the drawdown is the deal. That’s the thing that breaks the traders. Would you agree or are there other things?
Hugh: Oh, no. I totally agree. That’s what I’m doing right now. I can totally relate to that.
Walter: Yeah. We all go through it. Here’s the thing, everybody goes through drawdowns and you’re biggest drawdown is in the future. A trader just told me that the other day and it was really true. It’s sage advice.
What matters is how you’re going to pull yourself up out of that and the best way to do that is to have your plan already ready. You know it’s going to happen and it happens, boom! You have it happened and bam! Boom! Your plan is activated and you pull yourself up out of that.
That’s it. It’s as simple as that. Usually, you’ll figure it out like you’ll go back and you’ll look at your trades and say, “Ah, okay, that’s what happened.” Or you’ll say, “Oh! It’s the bloody USD/JPY. That bull USD/JPY keeps doing that to me so I’ll just keep going to throw it out.”
Forget it. Don’t trade anymore, it’s not worth it. If it’s running out at 70% loser rate and typically it’s a 55% win rate, it’s not a 70% loser rate and you’re only winning 30% in your trades, kick it out and say, “That’s it. Maybe the USD/JPY is just too weird now.”
These are the sort of things that you can do and, really, that’s the situation. As far as being mentally prepared, I think you would agree, Hugh, that when you do your backtesting, that’s what gives you the confidence. Going into it so you could survive those drawdowns.
Knowing that you’ve got these numbers behind you, you’ve got this much data behind you, these many trades and you can say, “Look, this system works, man. I know it works. I’ve got this behind me and I’m going to for it. I don’t know what’s going to happen in the future but if the past is any clue, I’m going pretty well with my system as long as I stick to it”
Hugh: Yeah, for sure. I think that’s the biggest confidence booster you could ever have aside from actually trading it live and doing well. But, backtesting, I think is the biggest way to do it.
Walter: Yeah, you just build up that confidence. That’s what I would say. A plan for dealing with drawdowns, building up your confidence with your testing and just knowing that you really need to have.
It’s kind of like you call an ambulance. You call the ambulance, “Oh, something happened, pick me up.” And then the ambulance, they have this checklist that they go through. You know what I mean?
When they get there, it’s like boom! They want to make sure that you’re okay and everything. That they can lift you up and take you to the back of the ambulance and drive you to the hospital. How fast do they need to drive? Is it like, “Boom! We’ve got to get you there quickly”? Or is it, “We just need to get there at good pace.”
All these things that kick in, that’s what happens when you hit your drawdown. It should be the same sort of deal. It’s like you do this checklist that you go through and you just want to work through it.
The thing is, it doesn’t mean you’re a bad trader. It’s just a bad luck. It just means that you have a lot of losers clumped in together and that’s it. That’s the most likely result. If you’re doing everything right, that’s the most likely result.
You’ve just had a lot of losers clumped together and you just want to make sure that it’s not something else operating like a funky market, or that you’re doing something a little bit weird and changing it up, or there’s some sort of weird sabotage, or evil brokers stepping in the way of your profit or whatever.
You’ve just got to make sure that that’s all. That’s all clear and you can get back on the horse. It’s a great question.
Hugh: Okay, cool. That’s awesome!
Walter: Thank you.
Hugh: Thank you, Walter. Really appreciate it.