Draw down, Whipsaws and my 3 months trading!

I have something to share from the recent trading experience in this volatile market enviroment.

Let me first put down few questions related to mechanical trading.

What kind of drawdown you should be prepared to absorb to avoid getting out of your trade?

How many whipsaws you can survive to remain holding the position in a particular counter?

Is it worth to remain entering all the trades in the counter despite it sucks all your capital slowly but steadily?

I faced all these questions since Jan till early may and didn't have perfect answers though i knew them partly. Now, I beleive i have those answers and let me share here.

After turning out to be a pure mechanical trader, this is the first longer whipsaw phase I have witnessed in my trading career. After doing patch of trials and patch of real trading in 2011 based on a mechanical system, decided to load the guns fully in 2012. Started with more capital from Jan'12 and increased the trade basket size. I have settled with Crude oil and Silver and partly with Nifty. What happened then? When you expect something, it won't happen!

Let us find answers for the three questions at top, from my own experience.

Q # 1: What kind of drawdown you should be prepared to absorb to avoid getting out of your trade?

Ans: If you have a faith in your system and if you have earned money for some time, then be prepared to take any deep cut i.e. the very deep drawdown in your account. Since Jan till end April, I had 120% drawdown from my margin money. I beleive this is not the worst and i may have more draw down also in future when the volatility is going to be at its best.

Q # 2: How many whipsaws you can survive to remain holding the position of the counter?

Ans: If you are experiencing whipsaws means, markets are seeking direction. It has no signal from the market participants after a bigger move or pretends that it has no signal prior to bigger move. In a mechanical trading, it’s very hard to skip the whipsaws till you gain some knowledge and experience. Let the whipsaws run and do not count them as it’ll frustrate you. I had 21 consecutive whipsaw trades in crude oil which resulted in the drawdown I explained above. This phase was going on for three full months. The 22nd trade wiped all the loss from 21 trades and yielded extra profit of 40%. And the best part is, that profit was poured in just 3 days! 3 months of frustration was cured in just 3 days in a lightening speed. So, make it clear that whipsaws are part of the game and you don’t need to break down for the same.

Q # 3: Is it worth to remain keeping position in a particular counter despite it sucks all your capital slowly but steadily?

Ans: When crude oil was boiling my account with 21 whipsaw trades, Silver was also in competition with crude oil to beat it’s record. Silver was making its 20th whipsaw trade but I had to quit the position as I was in a position to remain in either one of the crude oil or Silver due to shortage of funds. Considering various factors, I have decided to say bye to silver and stuck with oil. When I left silver, my silver account was down by 70%. After couple of days, It had its bigger move and within a week and needless to say it has produced 120% of returns.Managed to pocket part of the profits here by entering in a mid-way.

This has become a routine with mechanical trader that he takes all losses in the whipsaw mode with the hope that “bigger move is here”! But, when he is in the kissing distance of such move, he exits the position. This was a repeating story for me in 2011 but I have made all arrangements and mentally set to avoid this situation this year.Still, I was able to sat tight only with crude oil but had to dump silver. So, it doesn’t matter how bad the whipsaws, you shouldn’t exit the position if you are following a mechanical system. Prepare youtrself in such a way!

Now, what am going to do to avoid all the above three situation as it would happen quite often month after month and year after year! That’s for sure!

Simple – I am going to trade only with 33% of my trading capital.

If you want to make money from the markets, do not fund your account with just little above the margin money. I was having the theory of keeping 100% of the margin money in reserve i.e, you trade only with 50% of your capital available. Now, I’ll make sure that I keep 2 times more than the margin money in my trading account i.e., I would utilise only 33% of my trading capital and the rest would act as the shock absorber to manage drawdown.

Note # 1: One must understand the difference between hope and trust. Hope sometimes is dangerous (thanks to shashank redemption). Do not blindly hope that after certain draw down or whipsaws, you will get windfall returns. You should have done your home work i.e, back test, paper trade or the real trading for some time which should reinforce your trust in the mechanical system you are trading. So, if you can trust your system, stay calm at such testing times but never blindly remain in hope!

Note # 2: Someone can have the doubt as “Is it worth to trade with only 33% capital?” My answer would be – It’s damn worth coz you are going to execute all the entries and not going to leave a single entry. This would make you richer than what if you would have traded with your 100% capital by missing few trades!

Note # 3: All the above are applicable only to the fellows who really can’t spend their full time in the markets but wants to make money using a mechanical system. If you are a full timer and can make more money by spotting trends and whipsaws, then skip this post :)