Break Out of a Trading Dry Spell

04/29/2011 3:00 pm EST

Focus: STRATEGIES

Michael Toma

Author, The Risk of Trading: Mastering the Most Important Element of Financial Speculati

Whenever a trader's success rate drops, it's time to take a careful look and act decisively, says professional risk manager Mike Toma, who defines the key items to evaluate.

Even the best traders have times when their success rate drops and they’re not doing as well, but how do you recover from that and get back on track? 

I’m here today with Mike Toma, he’s a risk manager and a trader; we’re going to talk about that.

So Mike, if I’ve had some success and all of a sudden I stop having great trades and my success rate drops dramatically, what do I do about that?

Well the first thing I like to do when I’m auditing trade journals or doing some risk assessments on clients is to really look at what’s the root cause of this. 

One of the things I find traders have a problem accepting is the art of randomness. That applies at any type of numerical scheme, whether it’s sports, trading, even some casino-type games. 

Even World Series champions have lost three or four games in a row [in most years] when they win the World Series.
 
Really I want to see is do they accept the fact that we’re in a game? We have to accept the fact that you will have drawdowns.

What I like to do is say, OK—you know, it’s kind of like good cholesterol, bad cholesterol—is the art of this randomness, is it affecting, and the drawdown, is it from compliance, plan compliance? What is the root cause?

And get a sense of if they’re following their plan effectively, and maybe it’s just a natural phenomenon of the randomness taking place, which we should expect.

If there is non-compliance within the plan, maybe they’re not trading the set-ups after a loss, or maybe they’re just getting scared, or they’re just missing trades or missing good entries. Now I’m going to look at lessons learned. Is there an issue here we have to address, and address it rather quickly. 

Again, this whole game is based on bankroll; once that’s gone, game over. 

How do I know then if it’s just a temporary randomness of probabilities, or if my system is really not just reading the market, or I’m not reading the market correctly anymore?

Yeah, it’s a good question. I think what’s really important for the traders to do is not just trade effectively or whatever or however they would define that. 

It’s really important, I think, that you use the data in your trade journals to really say what happens when I’m having these negative impacts.

I like to look at if they’re violating plan rules. It’s a really good key indicator. 

Are they adding contracts after losing trades or are they missing things. Really I’m looking at plan compliance. 

It’s not about wins and losses. I’ve seen some successful traders have 80% success rates and be out of business. Conversely, some options traders have 30%, 40% success rates and they’re trading on the odds. 

What I really want to know is if they are trading the plan effectively and within compliance of the rules set out in their plan.

Once I’ve determined, let’s say, that I’m not following the rules because I’m not being disciplined enough, what do I actually do then? Do I reduce my trade size? How do I get back in the game?

Actually one of the risk management, even money management rules that I really instill on my clients and even really express for all traders is, when you go through those drawdowns, you actually really need to reduce that contract size.

Learn at a lower rate; I’ve always said that. Once things are going well, you can get back to normal speed. The markets aren’t going to go away anytime soon, so you don’t have to push that envelope.

I see a lot of traders during their lesson-learned phase go out of business. Really it was just a question of now they learned their lesson and they can’t trade anymore.

Really look at that plan, look at the results, and determine—rather quickly—and take a step back and say what am I doing wrong here.

Now if there were other set-ups that are working effectively, continue on those. Maybe it’s only just the particular set-up. At the same time, always got to step back; step back and at least lower that contract size.

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