Losses, not Profits, will Stop You from Trading in the Market


Should the market turn against you, it is important that you design a system that will produce as much loss as you are prepared to take. This loss, known as drawdown, is the maximum amount by which your trading float will temporarily drop at anytime. Doing this in advance, will help you avoid nasty surprises in the future. This gives you the confidence to continue trading when the good times start once more.

It is very unlikely that you will stop trading if your system is trading profitably. However, if you are in a trading year that takes too big a loss, you are likely to stop trading, even if your system has been tested and shown to make a profit over a longer time period. Therefore, design a system based on the risk you are prepared to take which includes a budget for your drawdown.

So how does one pick the best formula for your drawdown time? I will rephrase this question. How many losses in a row should you allow for?

First, I will use the simple example of tossing a coin. If I tossed a coin and it landed "Heads Up" 10 times in a row, are you surprised? However, if I tossed the coin 800 times, your outlook on the results are different.

Trading uses the same scenario. When testing your trading system over many years, you will find a run of 10 losers or 10 winners in a row. Mathematics provides some answers to the likelihood of this happening.

See the examples given in the table below:

----------------------------------------------- Probability of Losses in a Row ----------------------------------------------- System Win/Loss Ratio 60:40 50:50 40:60 ----------------------------------------------- 5 losses in a row 1% 3% 8% 6 losses in a row 0.4% 2% 5% 7 losses in a row 0.2% 1% 3% 8 losses in a row 0.1% 0.4% 2% 9 losses in a row 0.03% 0.2% 1% 10 losses in a row 0.01% 0.1% 0.6% -----------------------------------------------

A typical trend following a system has a 50:50 win: loss ratio. That is, half of the trades are winners and half losers. This is not a problem, because winning trades will make a larger profit than losing trades will make a loss.

A 50:50 system has a 1% chance of seeing seven losses in a row. Therefore, most trend following systems should budget between five and nine losses in a row. The good news is that there is the same chance of getting between five and nine winners in a row!

I hope you see the importance of making these decisions before you begin trading. Making the proper decisions before you start is what successful trading is all about.

-=-=-==-=-=-=-==-=-=-=-=-=-=-=-=-=-=-=-
David Jenyns is recognized as the leading expert when it
comes to designing profitable trading systems.

His most recent course Trading Secrets Revealed is a step-
by-step trading roadmap to having excellent money management.
Learn how *you* can become one of his students.
Click Here ==> http://www.trading-secrets-revealed.com

Receive David's free trading tips by sending a blank email
to: ==> trading-secrets-revealed.com@getresponse.com
-=-=-==-=-=-=-==-=-=-=-=-=-=-=-=-=-=-=-

MORE RESOURCES:
RELATED ARTICLES
Stuff
I continually hear from economists, talking heads, other market letter writers, analysts and assorted "experts" that I need to know all kinds of "stuff" about the stocks and mutual funds I am going to buy and I should keep up with them on a regular basis.What is this important "stuff"?Let's see.
"Fears Only Enemy Is Action"
What a great statement!I just heard someone use it in the context of personal and financial success and it struck me as a brilliant summary of an issue we raise in the SMG Tutorials.Fear is a huge issue with a lot of traders.
Cash Is A Position
I go to the Money Show every year to visit with friends who have booths and are speakers. Then when folks are filing out of lectures I listen to their comments on what I know the speaker has been saying.
Mutual Funds are Dead
You may have wondered why your mutual funds have been going down for the past 2 years. The answer is very simple, but not one you will hear from Wall Street as they want you to send money.
Investment Research - The Dalbar Study
Very few people, even professionals, have heard of the Dalbar Study that originated in 1995. Its purpose is to determine the profitability of trading for the small investor of mutual funds.
Bollinger Bands Strategies
The Bollinger Band theory is designed to depict the volatility of a stock. It is quite simple, being composed of a simple moving average, and its upper and lower "bands" that are 2 standard deviations away.
Low Tide
When you stand on the ocean shore and watch the waves breaking you might become aware that the tide is coming in or going out. It is a slow process to watch the water retreat and when it finally gets to its lowest point it is almost impossible to tell if it has stopped or will retreat further.
The Value of Stocks of a Company
The debate rages all over Eastern and Central Europe, in countries in transition as well as in Western Europe. It raged in Britain during the 80s: Is privatization really the robbery in disguise of state assets by a select few, cronies of the political regime? Margaret Thatcher was accuse of it - and so was the Agency of Transformation in the Republic of Macedonia.
Gold Fever
Right now there doesn't seem to be any "gold fever". Very few are out looking to strike it rich in this sector.
Successful Trading - Taking Profits - Part 1
So you're started trading, you bought some positions with your online broker, you've set some reasonable stop-losses to protect your account and all of a sudden one of your positions move strongly in your favor - so what do you do now? This my friend, is probably the hardest situation to deal with in trading the market - believe it or not.Do you take profits? Do you hold on for more profits? Do you take partial profits? There is no textbook answer to these questions as it depends on your trading objective.
Stock Analysis
I receive emails from Morningstar. This company provides statistics and analysis of just about every publicly traded stock company you can think of as well as voluminous information on mutual funds around the world.
Its Snowing
The Winter Games for the Olympics are coming up soon and many will want to go to see the giant slalom event. That's the one where the skier starts off from the little hut at the top of a long slope, picks up speed and makes his way around poles on the way down.
The POWER of a Proven Stock Investment Plan
When you invest in the stock market for ever-increasing cash dividend income, verses trying to make a buck in the stock market, your mindset will change. There will no longer be a fear of losing money in the stock market.
The Secret to More Winning Trades is as Simple as Avoiding This Common Mistake
If you're a normal human being, your need to feel good about yourself probably causes you to sell your winners too soon - and -- your need to avoid feelings of regret, causes you to hang on to your losers too long.At one time or another, we're all guilty of letting our emotions dictate our investment decisions.
Complacency
During the month of January the Dow Jones Industrial Average, usually referred to as the DOW, had an almost 1,000 point range, most of it down and the average investor has yawned and said 'so what, this has happened many times before'.Is there any reason to worry now?The terrible event of September 11 shocked investors who sold heavily and then watched the market climb back to where it was on September 10.
Your Trading Objective: Why is that so Important?
You've decided to try your luck at trading stocks or commodities, but so called experts tell you that you need to determine your trading objective. What exactly does that mean and why is it so important? Well, it's really a question of your trading philosophy.
Gurgle Gurgle
Caught in a whirlpool and being sucked under. No life vest or other device to save you.
Maximizing a Stock Market Investment
Maximizing a stock market investmentThere are several factors an investor in the stock market should consider for a maximum return on an investment:1. All stock purchases should be commission-free.
Stocks: Understand What You Buy!
"There is nothing more frightful than ignorance in action!" Johann Wolfgang von Goethe (1749 - 1832)I don't really know how cars actually work. Not really! I know how to drive them, but if you asked me how they work, I would not really know how to definitely explain it.
Wal-Mart: Discount Store, Discounted Stock?
As GuruFocus updates the stock buys and sells of gurus, Wal-Mart (WMT), the discount retail giant, stands out as the stock with a high ValueRank (7 out of 10). Just recently, Clipper Fund's James Gipson and T.