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How to handle draw down
Let’s say you are doing everything right and you experience a 10% drop
in your trading account, how do you handle this? The draw down
is the amount of the decline in value of a trading account, expressed
either in dollars or as a percentage, between its highest and lowest
points. Here are a few ways to handle a draw down, something you’re
bound to face in trading at some point.
1. Most of the time a loss is contingent upon overall market
conditions; it is imperative to identify the nature and character of
the loss. For instance, a draw down can be expected if you go against
the market in the process of positioning yourself. Getting into
position early and being ready when it happens is your consequence for
the draw down.
2. Define the nature of the losing trades and if you can get any
follow through on a stock. No follow through means it is time to adjust
and wait for a pullback. A pullback in stocks is a drop in price after
there is an impulsive move up. Option traders can use a pullback as an
opportunity to initiate a new position.
3. Review your market bias, are you over-weighted on one side?
Applying a mix of longs and shorts can balance a position making it
more neutral. This is a good technique in option trading anyway.
4. If you find yourself weighted in a sector that is hurting you,
unwinding positions that have caused you to ‘marry’ a sector can be
your best option. Marrying a stock is considered holding a stock for a
long period regardless of other investment opportunities or indications
that the security should be sold. Becoming this attached to your
options is unwise, because an investor’s needs and the desirability of a
particular stock will change over time. In options trading, you need
to stay on top of things and get rid of options that are no longer
useful.
5. Sometimes an option trader can find themselves at the wrong place
at the wrong time. When money is being made elsewhere in the market;
unwinding positions as much as possible can help remedy the situation.
Overall, draw downs are a part of trading. They can result
from a plan consisting of going against the grain as you look for a
sharp reversal, unbalanced market bias or the need to re-evaluate and
re-group and begin again.
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