Farley: Don't Sweat a Drawdown, Learn From It

On one hand, this pain is a wakeup call to adjust your strategy and reduce risk exposure. But even the best traders can't avoid drawdowns entirely. At its core, these losses are just a natural outcome of playing the financial markets. Of course, I doubt that piece of wisdom makes you feel any better when the market is beating you up.

Emotional extremes are difficult to manage during a major drawdown period, and they can prolong the pain unless the trader gets control fast and maintains a good attitude about losing money. I know this sounds hard, but despair and profit rarely travel together. And it's very easy to turn a string of moderate losses into a full-blown disaster.

Change Gears

Strategic changes to your trading methodology will lower the emotional fires during a drawdown period. At the top of your list: Reduce position size and don't try to recoup your losses in one high-risk trade. This is a revenge-motivated activity that sets up market players for a catastrophic event that can take them out of the game permanently.

The key goal during a drawdown is to preserve capital until conditions improve. Smaller positions let traders get their minds into a healthy state and back in harmony with the market flow. The smaller profits obviously won't undo the prior damage, but they will help to re-establish the methods and workflows that paid the bills in the past.

Review your trading plan in detail, looking for major flaws that are aggravating the loss cycle. It might feel good to blame the 2008 market for your failure to make money -- we all do that at times. But in reality, that's just an excuse that blinds you to the real reasons for your dwindling capital.

Reality Check

Drawdown periods can force traders to experience a level of impotence that can be very frightening. Many discover their profits came during a period during which everyone else was making money. They finally realize those happier times induced ego gratification and a false belief that they had become genuine market players.