One of the biggest problems with drawdowns is that they seem to come out of nowhere and catch you off guard.
There’s never a convenient time for a drawdown – in fact, they have a knack for selecting the worst possible time to occur.
But you don’t have to be caught completely flat-footed.
After being blindsided by drawdowns several times, I got fed up and came up with an approach that works really well.
When I optimize a trading strategy initially, I create two versions.
The first version is the one I’m planning to go live with – my best guess at the optimal way to trade the strategy.
The second version, however, is one with fewer but more profitable trades than the first version.
If you go back to the example strategy I shared a few weeks ago with different versions, I might go live with version one:
Version 1:
- Profit Factor: 1.87
- Win Percent: 53.8%
- Trades: 3,859
- Trades per day: 3.3
But then hold version two in reserve to have ready to go if the strategy goes into a drawdown:
Version 2:
- Profit Factor: 3.29
- Win Percent: 55.1%
- Trades: 1,619
- Trades per day: 1.4
This approach gives you a systematic way to plan for drawdowns from the outset.
And when you’re optimizing your strategy, you’re in exactly the right mindset to create this plan.
If you wait until you’re already in a drawdown, you’ll be frustrated and pissed – exactly the wrong mindset you need to come up with a plan.
-Dave
P.S. If your backtested strategy is in a drawdown, you can use the Strategy Cruncher to improve it. One trader told me this week that he covered over 2 years of the Cruncher’s cost with just a single use.
