Lessons From Drawdowns

The bond between you and your discipline can never break

Since 2011, my investment strategy (and my investors) has incurred two losing streaks of -23% and -20%. It’s not exactly fun to sit through these losses, but it’s part of the deal. I’ve struggled with the idea of losing my entire life, but I’ve come to grips with the fact that it’s about as natural as winning — especially in trading.

The facts say that every strategy and manager loses money from time to time. After you accept this reality, you start viewing losses as not something to avoid but to embrace as part of the process. This is weird for the few couple of times, but you gotta trust me on this.

Losses provide us with opportunities to learn about our strategy and ourselves; in particular, if we’re still compatible with our strategy or not. If we are, then we continue following it. If not, we modify it.

At my firm, Melissinos Trading, we examine our methodology during every losing period.

We ask questions. Are we diversified enough? Are we missing out on any big market trends not currently in our portfolio? Could we have gotten out of losing trades sooner? Could we have allocated more heavily to the winners? Did I not follow the plan correctly?

Over the last five years, I’ve learned a few things from the tough periods: the “fist-pounding” indicator and it’s positive intention; the importance of communicating with investors and to gauge confidence levels; how to emotionally budget for and cope with losses; homework builds confidence.

Top Three Things I’ve Learned From Drawdowns

Fist Pounding. No matter what, during every losing streak, big or small, I get to a point where I pound my fist on a table, bed or sofa. I cannot stomach losing even if my system tells me to expect it from time to time. I can lose my perspective and go to town slamming my fists into the couch.

I grew up watching Derek Jeter, Joe Montana, Tiger Woods and Greg Maddux — guys who dominated for years. I began to think dominance was normal, so at a young age, I became obsessed with not only winning, but also winning big. Real big.

I remember wanting to be so good that a debate was a waste of time since everyone knew who the best was.

Today, I carry this attitude into my trading. I understand I cannot win on every trade, but I set my sights on producing the highest absolute and risk-adjusted returns as I can every year.

Fist pounding alerts me of my deep desire to win and to get focused on improving the trading strategy.

Group Effort. No one does it alone. Success does not derive from some secret sauce or magical algorithm.

Ask any successful individual about their “secret”. They always give credit to their teammates who supported them along the way. Ask Navy SEALs who the “Rambo” of their community is and they laugh; they succeed because of the collective effort of the Team.

This, I believe, is the real secret: to organize a group of people to work together to achieve a goal.

Yes, it’s a boring answer, but this is what experience tells me. Sometimes I wish I could just do it all on my own. It’d be much faster and cheaper, but it also probably wouldn’t be as fun.

At Melissinos Trading, no one invests because they feel pressured or obligated to. I don’t “sell” anyone on anything; at least I try not to.

Instead, I express the goals of the firm; what kind of performance and volatility to expect over time. I fully explain my philosophy and how the strategy works. With this information, the investor can determine whether the investment suits his / her risk tolerance. This process sheds the weak hands. Our investors don’t care about short-term results, but instead commit to supporting me in following the system.

Without a complete explanation of how the strategy works and it’s performance expectations, I believe our returns would suffer; investors would chase good returns up, bad returns down while I tried to keep everyone calm. That’s not my idea of winning formula.

During losing streaks, if and when investors lose confidence, I make it a point to reconnect and see how they’re feeling. We discuss all of the points we did in the initial conversation to determine whether they’re still well suited for an investment.

Rapport-building goes a long way to building trust and helping investors see the big picture. Many times, they even help me maintain perspective. In a results driven industry, a tight knit team is a major advantage.

Homework Helps Psyche. Drawdowns can be draining. In tough times, we all need something to lift confidence and stay the course. Some resort to hope. Others resort to doing some work.

I draw confidence from doing the work. During a drawdown, I double and triple check everything. I make sure I’m following all of my rules correctly; that my data is accurate; my orders are correct. I rule out any human error before diving into the research to see if current markets are behaving differently than they have in the past.

For me, homework eliminates stress and pressure. It’s been this way since grammar school. It reassures me that I’m doing the right things; that I’m not making careless mistakes.

Doing the work can go a long way to rebuilding confidence, especially in drawdowns. While everyone else is jumping ship looking for the next get-rich-quick scheme, we’ll be looking ourselves in the mirror and trying to improve. What other choice do we have?