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Trading slumps shape great traders

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“Every trader faces it. Only winners know how to handle it. The dreaded losing streak rears its ugly head every so often and attacks every great trader.

It eats away at your judgement; it saps your confidence. Sometimes it can take you so low that you think you’ll never get out.

You’re sure that something has gone wrong, that you’ve lost your touch.”

Martin “Buzzy” Schwartz- Pit Bull. Lessons from Wall Street’s Champion Trader

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Losing is painful. And losing day after day for long periods of time is disorienting and potentially destructive. If you’ve only had winners during a bull market, these losses can be psychologically devastating.

Months ago, you could do no wrong. Now, nothing seems to go right. It is these difficult periods that shape who you will become as a trader. Great traders are never made in bull markets, they are forged in pain, adversity and challenges. If you are in a slump, that pain, adversity and challenge is part of your development and formation. 

Your first slump is part of your long term preparation.   

Punishment from the inside

Trading slumps can be periods where you take endless small losses like a thousand paper cuts. Long stretches where you can’t figure out how to make money. Or quiet markets where you can’t find an edge. 

Trading slumps are characterized not just by financial losses, but by fear, inaction, depression and a loss of confidence. 

These feelings are unsettling. They have a way of bleeding into every other aspect of your life. Your sleep becomes less restful. Healthy lifestyle habits may fall by the wayside. You feel lethargic and heavy. Everything becomes a chore. 

But it won’t always be this way. It won’t last forever…assuming you embrace this moment and learn from it. 

What you can and can’t control

Embracing the moment starts by taking stock of the things you know you have control over as a trader, and the things that you don’t. 

You have control over your interpretation of events.

You have control over your trading process, resource allocation and your execution. 

You have control over what and when you trade. 

And you also have control of what you do during good market periods in anticipation of weaker periods.

What you don’t have control over is the behaviour of the market or other participants in your market.

Now looking at the items within your control, you can start by working through these areas in a systematic and rational way. 

Change your perspective

Your interpretation of events is the most important item on your list. If you interpret the market as a threat, a scam, a danger, something you fear in some way, then your first step is to get your head straight. It’s time to reframe your thinking. 

This reframing will change your thought process. It will help you deal with the emotional burden of a painful period. Because when you are afraid, you will hesitate and fail to take risks. Fear and lack of confidence drive you to take losses too quickly, missing key moves on sharp, shallow reactions. Your caution leads to overthinking and overriding solid trading plans, only to see your idea play out…which further burdens your already weakened confidence. 

It’s not personal

When you begin to accept the idea that you can’t get anything right, losses become personal. This acceptance becomes a form of need. A need for a win. That need drives either excessive or suboptimal position size. The need manifests itself in erratic trading activity that is purely reactive and out of sync with market sentiment and movement.

And once that hole you are digging becomes deep enough, the desperation increases and these activities become magnified. Then you start trading not to lose. 

Human beings extrapolate the future from the past. When times are good, we think times will be good in the future. When times are tough, we assume these times will never end. As a trader, you will learn that these assumptions are flawed. Periods where people think the good times or bad times will last forever, are moments to look for the other side. They are opportunities to shift your thinking and your focus. 

So start with reframing your slump into a learning experience. An opportunity. Part of your formation as a trader. 

Scale back. Dig deep. Small changes. 

Once you’ve reframed your slump into an opportunity, cut your trading back while you dig into your trading process. 

Your trading plan outcome evaluations will prove valuable now. They will provide you with insights into what you are doing and why things might be going sideways. Look carefully at the thinking behind each trade. The execution. The market conditions. Then examine the outcome. 

If your slump is occurring in a strong, liquid market environment, perhaps you have an internal personal problem that’s negatively influencing your decisions and interpretation. You may have a structural problem like not taking on enough risk or your stops could be too tight. Maybe your trading process needs further refinement. 

Start with one element at a time. Make an adjustment and test until you get back on track. Strong, liquid markets forgive small mistakes and can help you recover from larger ones. 

Ruthless markets require ruthless evaluation

If your slump is taking place in a down market, these types of markets tend to be more ruthless and unforgiving, so your approach should be different. Here your mission is to protect your capital as much as you can. 

Start by taking a look at your trading process and approach. It may be valid but not valid in every market condition. So you have to ask yourself if it’s better to sit and wait. You don’t need to trade every day or have a position on all the time. 

If you are confident that your trading process is sound, sometimes waiting for the right market conditions can be the right approach. However, during these periods, you may want to stay in tune with market activity so that you are ready as the market adjusts to your strengths. This means using small trades as series of market condition experiments. 

Using small amounts of capital on each trade will allow you to manage your market tuition payments. Tuition will help you to determine when and where to deploy your capital and system next.

Protect yourself from the vaporizer

Too often, traders fail to recognize the change in the market, and try to will their way to profits in a declining or flat market. This approach vaporizes valuable capital and destroys psychological resilience and confidence. 

A lack of discipline in a declining market eats up a lot of time and energy. And when the next move eventually comes, these fighters are too exhausted. They are too beat up and capital depleted to take full advantage of the opportunity in front of them. 

When you’re in a slump, you will also learn important things to help you in the next one. Like, when you are in the midst of a bull run, it’s always good to start planning for a change in market sentiment and profitability potential.

That means the more successful you are and confident you feel, the more you should remind yourself that a market goes up and down. Set aside capital during periods of extreme optimism and profitability to provide yourself a cushion for those periods where your trading may not be working. A solid capital cushion will protect you psychologically when the market is taxing, and you are dolling out tuition. 

This financial cushion gives you strength when a reversal comes. It gives you mental and emotional durability when other market participants are chewing their fingers off, frozen by fear and doubt. 

Slumps make traders. They test their mettle. They help them develop valuable skills for the upside and future downside. So embrace downturns as opportunities to grow. And make sure to take the steps necessary to work your way through these periods and come out stronger. 

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