How to manage trading drawdowns and recover from losses

How to manage trading drawdowns and recover from losses

Reading time: 7 minutes

A losing streak can happen even to the most experienced trader. A trader may see his balance fall, but that’s not the worst part. It is to stay disciplined enough to avoid letting a slight drawdown into a much larger problem. The difficult part is staying disciplined and preventing a period of drawdown from becoming a much larger problem.

At FP Markets, we believe that learning how to pivot from a trading drawdown is just as important as knowing how to find new trading opportunities. With the right guidance, losses can become valuable information rather than a trigger for impulsive decision-making.

Navigating a trading drawdown

A trading drawdown refers to the decline in the value of a trading account from a previous peak to a subsequent low prior to account recovery.

In simple maths, a trading account that grows from $10,000 to $12,000 before falling to $11,000 incurs a drawdown of $1,000 (approximately 8.3%).

Drawdowns are a normal part of trading. Even sound strategies with a positive long-term expectancy can run into periods of losing trades. It’s impossible to eliminate drawdowns altogether: the key is to keep them within a level that you can manage; financially and psychologically.

When are drawdowns dangerous?

On its own, a small loss rarely causes serious effects. The bigger risk is how a trader responds after that loss. After losing several positions, it can be tempting for a trader to increase trade sizes in the hope of recovering losses quickly. Another common mistake is traders abruptly abandoning their trading plan, which could include taking lower-quality setups or rushing to enter positions because they need to win back what they lost.

These reactions can set in motion a damaging cycle:

Loss > Frustration > Larger Risk > Further Loss > Emotional Trading

Breaking this cycle entails a change in mindset. Instead of focusing on recovering losses immediately, a drawdown should be treated as a period of assessment. A challenge to win back money as quickly as possible.

Start with the numbers

After a loss, before taking another trade, you have to know how severe the drawdown actually is. First, review your account’s peak equity, current equity, and percentage drawdown. It is also useful to review the number of consecutive losing trades and compare current performance with past results.

These numbers matter because perception can exaggerate the problem. A trader who has experienced four consecutive losses may think that their strategy has stopped working, even if those losses fall within the range observed in its historical results.

Of course, an unusually deep or protracted drawdown should not be ignored. These are some questions to guide your review:

• How large is the current drawdown?
• How long has it lasted?
• Is the loss consistent with previous trading results?
• Have certain market conditions changed?
• Have I followed my original trading rules?

Answering these questions can separate a difficult period from a genuine change in strategy performance.

Review your strategy before changing it

Avoid the temptation to change your strategy after just one drawdown. A few losing trades don’t automatically mean your system is broken. Markets move through different conditions, and a strategy that performs well in a once trending environment may struggle when markets become range-bound, volatile or unusually news-driven.

Before replacing your approach, review areas such as:

• Entry quality: Were trades triggered according to your rules?
• Risk management: Did you maintain your planned position sizes and stop-loss levels?
• Market conditions: Were you trading in an environment that suited your strategy?
• Execution: Did slippage, spread widening or poor timing affect the results?
• Behaviour: Did you override your trading plan because of fear, frustration or impatience?

Breaking down what actually happened that caused the drawdown will flesh out if the problem was with strategy, execution, or trading discipline.

When confidence drops, reduce risk

A drawdown does not necessarily mean you need to stop trading completely. But if you are concerned about further losses, we suggest reducing exposure to give you some room to take back control.

Suppose you typically risk 1% of your account on each trade. During a difficult period, you might choose to reduce that amount depending on your risk plan. Smaller positions means that individual losses have less impact on your account while you assess what’s happening. The important point here is to reduce risk deliberately, rather than changing position size impulsively after every win or loss.

Suspend the urge to trade bigger

Under no circumstances should you engage in revenge trading! After taking a loss, a trader may feel a strong urge to recover the loss. The emotional pressure can be heavy and can result in taking oversized positions, too many trades or entries that would normally be ignored.

Trying to force the market to pay you back can be a gateway to a longer losing streak. Therefore, you must have a recovery plan in place that focuses on the process, instead of recouping a specific amount. You may not be able to recover a drawdown in a single trade, but you can focus on returning to a disciplined approach and making decisions based on your trading plan.

Create a drawdown action plan

A well-written drawdown plan can establish specific thresholds and actions. For example, traders may decide that after reaching a certain percentage drawdown, they will take steps like reducing position sizes, stop trading temporarily, or even conduct a comprehensive strategy review.

The fundamentals of your recovery plan include the following:

• Maximum acceptable drawdown - Decide what level of loss could trigger intervention
• Risk reduction rule - Know when position sizes should be reduced
• Trading pause - Set conditions under which you step away from the market
• Review process - Factors you will examine before returning to normal risk
• Return-to-trading rule - Determine what criteria should be met before increasing your exposure again.

Give your strategy enough time

Resist the temptation to demand immediate results. Rather than judging a strategy based on a handful of trades, a strategy should be tested and evaluated across a meaningful sample of trades.

A more useful question than ‘How can I recover this loss today?’ is ‘Am I implementing a strategy with a sound risk framework over a sufficient number of trades?’ This change in perspective can help reduce the emotional focus on short-term results and keep attention on the trading process.

Improve your trading plan with FP Markets

Take the time to review your position sizing, stop-loss approach, and drawdown limits so your strategy is built for both winning and losing periods. Learn more about various markets with FP Markets and continue developing a trading plan designed around informed decisions and long-term consistency. Open a trading account with FP Markets and start exploring global markets.