How to deal with large drawdowns?
My experience as a practitioner of the game
Hey everyone, Pedma here!
Have you ever went through a large drawdown both in length and depth? Felt uncertain and fearful that your strategy might never produce a profit again?
If you haven’t, it’s because you haven’t traded long enough. I have been trading for almost 7 years now, and today I will show you how I deal with these deep drawdowns.
I decided to write you this email after Danyl made a comment on one of my recent posts, with one of the most important questions when it comes to actual trading:
"How to ensure we’re sticking to the plan, if we’re in drawdowns at the moment we go live trading?”
I go through drawdowns all the time. It’s just part of business. Think about an ocean front restaurant, where the bulk of revenue come from the summer months. In the winter, does the owner ask himself if his business is broken? No! He knows it’s seasonal.
Our models are often seasonal also. If you regularly follow my posts, you know that I prefer to trade trend models. Trend features are not always present in the market.
Just as recently as today, I am going through 131 days in drawdown!
Is my strategy broken? Not at all. This is what real traders go through. I am not here to sell you dreams. Unlike trading “gurus”, I’d be willing to put $50k down in a bet, that I’ve beaten most of the “gurus” with those fake linear performance curves, in the past 4 years. (Sorry about the rant, I get angry quite easily when talking about some of the grifters in our industry)
We never know when the property that drives the returns of our models will come again. All we have to do is wait, and keep fishing.
But you need to know what you’re extracting from the market. (We’ll get down to solutions by the end of the article.)
Executing on a trading model is less about math and more about consistent execution.
The first question you should be asking yourself, before you launch any trading model is:
“How am I going to react when I go through the inevitable drawdown?”
Be as specific as you can, because you will go through them. Like a sailor navigating the storms of the sea. The storms will be there. Many times the only way out of the storm, is through it. The experienced sailor has better chances of surviving and reaching the other side unarmed. But the unexperienced sailor can do just as well, if he follows the rules, and let the navigation tools guide his way.
I thought I’d keep going with a real life story.
It was late 2021.
Everything that I touched turned into gold.
Literally, I am not exaggerating, if you were trading the crypto market in the late stages of 2021, you know what I am saying.
I think you’ll find this funny.
At one point, I was running a strategy that consisted of the following rules:
Search on twitter for the key word “OHM Fork” (OHM was a “passive income” crypto defi project, obviously it went nowhere, but it was all the hype back then)
In crypto there’s these things that we call forks. They are basically copies of projects, with different branding. So I’d check their website, socials and discord.
If their socials had over a certain threshold of following, their website was decently designed and their discord was active, I’d buy it.
That was basically the strategy.
The first trade I ever made on this strategy, I turned $300 into almost $4k in a few days.
This was when I discovered the potential there.
I was hooked.
Here’s a returns table from this strategy alone back then.
And the rest is history.
… crazy times.
You might be wondering:
“But Pedma, aren’t you a systematic trader? You can’t possibly have done proper backtesting on this.”
Sure I didn’t. But I also don’t miss opportunities when they’re there.
You have to take advantage of what makes money today, and when things are obvious, you attack.
Anyways, long story short, I made a decent chunk of cash.
But as November-2021 rolled over, so did one of the largest drawdowns ever in crypto.
And I was very exposed to crypto.
This strategy naturally began to decline, and so I had to pivot to more “professional” type strategies.
I was already developing my momentum models back then, but they were not as robust as they are today.
So I launched them at the peak of the bull market.
How much did I lose from my portfolio, are you wondering?
Here’s one of my wallets from that period.
I also wrote about it extensively here:
Although the growth in the portfolio is not only derived from my models back then, a bigger chunk was derived from services I was doing, to help out smoothing down the losses, as there wasn’t much to do, trading wise.
(The decline you see to $0 in May 2023, was re-allocation of capital back to my brokers, as my trading activities started to pick up again, when momentum returned to the crypto markets in 2023.)
The point of showing this to you is just to show you that I’ve been through the trenches, as our American friends say.
And I’ve survived.
I am not here just as a theorist, I actually have capital at risk and I think that’s important.
So how do you avoid blowing up your portfolio?
Let me make this very clear - you almost certainly already have the skill right now that you can use to survive the drawdowns. All that you lack is the confidence that you’re models are going to continue to work.
Ask yourself the following questions:
Do you know the expected historical volatility of your models?
Do you know the average and maximum drawdowns the model has incurred?
What about in other asset classes?
Do you know what the source of returns for your models are?
Are these source of returns, things that are known and well documented academically?
If you answer these 4 questions, you can battle through any drawdown that you will go through.
These answers will be your benchmark for when you go through tough periods.
But now the question is, have you carefully measured all of the details behind these questions?
If you can’t do it, that’s OK. You can either partner with an expert that will help you, or just learn by yourself. Go through all the history of posts that I’ve shared here. Go through my twitter, and the twitter of the people that I follow (I’ve got a good curation over the years).
The most important thing is that you have the answers to these questions, next to you at all times. When you are in doubt, you revisit the answers and you look at your current performance and see if there’s any major deviations from this normal behavior.
That’s how professionals do it. Consistent execution and re-assessment.
Markets will change though, but that’s topic for another day 😊
If you need any help with all of this stuff, that’s why I am opening a one-to-one coaching program, where I personally get on calls with you, give you a direct channel to me, to make sure you build and grow your systematic trading business, while making sure you don’t go through the same costly mistakes as I did.
If you’re an individual or enterprise, feel free to book a call:
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