Has this ever happened to you?
You have a really good week/month/quarter/year in trading, making a nice amount of profit.
Then the following week/month/quarter/year sucks, and you end up losing all or a big portion of those profits you made?
In fact, it happened in my Hedge Fund a few years ago – we had an excellent quarter and were up 84% return for the year. But then the following months we ended up giving back a significant portion of those profits.
It was extremely encouraging to see all those profits roll in, but then to see them vanish again was incredibly frustrating. We still produced a good return that year, but it wasn’t as good as it could have been if we knew how to protect our profits better.
Unfortunately, “protecting profits” isn’t something traders talk about alot.
There is a huge focus on drawdowns, and what to do when your trading strategies underperform, but what about when your trading strategies overperform? What should you do then?
This is what we’ve been trying to figure out in our Hedge Fund, and in recent research we uncovered some interesting insights.
Here’s the funny thing – overperformance and underperformance are both linked.
Robust trading strategies will go through cycles where they perform really well for a while, but then what usually follows is a period of underperformance, which usually leads to frustrating drawdowns.
Most traders will trade through that drawdown, and perhaps even stop trading the strategy if it reaches some maximum level of drawdown. But by that time it’s too late – you’ve given back all of your profits and maybe even more.
But what if you could stop trading the strategy BEFORE the drawdown occurs?
What if there was a way to take more of the good performance of the strategy, and identify when it was more likely to start performing badly, BEFORE it actually happens?
It may sound impossible, but if you can manage the overperformance of strategies, you can actually reduce losses and drawdown too.
In our Hedge Fund, we’ve identified a number of simple “leading indicators” that identify when a well performing strategy may be about to start performing poorly.
One simple way you can do this yourself, which only takes a few minutes, is to look at the equity curve of your strategies and notice what happens when it starts performing really well. What happens after that? Were there any “signs” when your strategy started performing poorly? Were there any “leading indicators” that your strategy was about to suffer?
If you can do that, you may be onto a powerful way to improve your trading performance by switching off strategies BEFORE they start a drawdown.
Happy trading,
Tomas.
PS. In the coming issue of the Empowered Trader newsletter, I share one of the most powerful “leading indicators” we’ve found for strategy performance. It’s something all traders can easily apply to their own strategies too.
Plus, we’ve even included a bonus “Modelling Simulator” built in Excel, that you can use to test this concept on your own trading strategies.
If you’re already an Empowered Trader member, look out for this valuable issue in your mailbox in the next few weeks.
If you’re not a subscriber to the Empowered Trader monthly newsletter yet, you can sign up here. (It’s only available for a few more days though, then it closes so we can send the final list to the printers for mailing).