Glacier Valley · Camp 3 · Crevasses
Drawdown
The valley floor is riddled with cracks in the ice: the Crevasses. Ayaz has everyone walk single file along the rope. If someone falls, the others drop to the ice and hold. Here you'll learn about losing streaks, how far an account falls from its peak (drawdown), and when to stop.
The camp's rules
- 01
Drawdown is how far your account falls from its highest point. Every system has drawdowns. The question is how deep they go.
- 02
Losing streaks are normal. With a 50% win rate, there's an 81% chance of at least one run of five straight losses in 100 trades. A streak doesn't change the rules.
- 03
Climbing out of a hole is hard. To recover from a 10% drop you need an 11% gain. From 20%, you need 25%. From 50%, you need 100%.
- 04
Turnaround time: set a daily loss limit (say, −3R a day). Once you hit it, no new trades that day. A climber turns back when the time comes, even one step from the summit.
- 05
A revenge trade is one you size up, or take off-plan, to win a loss right back. It's running along the edge of a crevasse.
- 06
When your account falls a set amount from its peak (say, 10%), cut your risk per trade (say, in half). When the streak turns, raise it again.
Teaching
Every system has streaks
With a system that wins 50% of the time, your chance of at least one run of five losses in 100 trades is 81%. For six losses, it's 55%.
At a 40% win rate (a good system aiming for 2R can look like that), five losses in a row is almost certain: 98%. Even seven in a row comes in at 69%.
A streak doesn't mean the system is broken. What tells you that is expected value turning negative across a logbook of hundreds of trades.
Ayaz · Rope master
Drawdown and recovery
If an account of 100 drops 50%, you're left with 50. To get from 50 back to 100, you need a 100% gain.
−10% → +11.1% · −20% → +25% · −30% → +42.9% · −50% → +100% · −60% → +150%.
Climbing out of a shallow crevasse is easy. Getting out of a deep one takes months. The real job is never falling into a deep one.
Ayaz · Rope master
Daily loss limit
Set a limit at the start of the day, say −3R. If the day's losses reach it, no new trades. Any trades still open are managed by their plan.
The limit is there to keep a bad day from turning into a bad week. After a run of losses, your decisions get worse and the urge for revenge grows.
If the account is a set amount below its peak (say, 10%), cut your risk per trade. When the streak turns, raise it again.
Ayaz · Rope master
Lessons · 5
- Story
Crevasses
Don't cut your rope when you lose. Learn to recognize losing streaks and revenge trades.
- Lesson
Losing streaks
See how normal it is to lose several in a row, and don't change the rules when a streak hits.
- Lesson
Climbing out of the hole
Work out why recovery gets disproportionately harder the deeper the drawdown.
- Lesson
Turnaround time
Set a daily loss limit, and once you hit it, take no new trades that day.
- Exam
Crevasses exam
Handle the streak, the drawdown and your turnaround time on your own.
Test yourself
You're about to take 100 trades with a system that wins 50% of the time. What's true about five losses in a row?
- ✓ I'll most likely see it at least once
- · It's very unlikely; if it happens, the system is broken
- · Impossible: at 50%, the losses spread out
Random sequences cluster. At a 50% win rate, a five-loss streak shows up in 100 trades 81% of the time.
A trader has been stopped out six times in a row. Their logbook shows an expected value of +0.3R over the last 300 trades. What should they do?
- ✓ Keep following the rules; the streak is normal
- · Drop the system now and look for a new one
- · Double the risk to make the loss back
Positive expected value over a large sample is stronger evidence than a short streak. Riding out the streak at the same small risk keeps the system alive.