Losing streaks, drawdowns and total open risk

Even a method in which half the trades close in profit will, over a few hundred trades, probably produce runs of six or more losses in a row. A run by itself says little about whether the method still works; it is what a series of independent outcomes looks like. Planning for it is part of sizing.

What a losing run does to your account depends on the risk per trade, not on the calls. At 1% per trade, eight losses in a row leave about 92% of the capital; at 5% per trade, about 66%.

A drawdown is the fall from the highest value of your trading capital to a later low. Getting back takes a larger percentage rise than the fall, because the rise starts from the smaller amount.

This is the case for a small risk per trade: it keeps drawdowns in the range where getting back is realistic.

Sizing each trade at 1% does not limit the total. Five open trades at 1% each put 5% at risk at once. If they are related, for example several banking stocks, or an index future and a large stock in that index, they can all reach their stops on the same day.

• Add up the rupees to the stop of every open position. Many traders set a ceiling, for example 5% to 6% of capital, and take no new trade above it.
• Count related positions as one larger position.
• An index call and calls on its largest stocks overlap.

A daily loss limit, for example three times your usual risk per trade, ends the session when it is reached. It guards against the decisions people make after a run of losses: larger size, unplanned trades and moved stops.

• Review in R, not rupees, so that trades of different sizes compare.
• Some traders halve their risk per trade after a set drawdown, such as 10%, and return to normal size only after reviewing their journal.
• Check whether the losses came from the calls or from execution: late entries, moved stops or oversized trades.

• Position sizing and risk per trade
• Trading psychology: common mistakes, and rules for each
• Glossary: R