As human beings we all hate pain even when its actually beneficial for us. Those of you who lift weights know that the only way to improve your muscle tone is to actually tear the fibers so that they can repair themselves and become bigger. Knowing that however, doesn’t make it any more pleasant to drag my butt to the gym every Sunday and endure the supervised torture of my German born trainer. Yet I do it because it keeps me healthy.
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However, few of us have such a positive attitude when it comes to dealing with pain in other areas of our lives. Be it physical, emotional or psychological – our general attitude towards pain is to ignore it and hope it goes away. As the very welcoming sign on the front door of the infirmary of my summer camp used to say – “Time heals all wounds.”
That may be a good strategy for an 13 year old with a stubbed toe – but its no way to go through life. I see this “ostrich head in the sand” behavior all the time in the currency markets. We are holding a position with no stop and it continues to bleed against us. So we turn the screen dark, or go for a walk, or go watch a movie and hope that when we come back the position is back to even.
Worse yet, if we are trading a strategy and it suddenly goes into a massive drawdown our instinctual response is to either turn it off or to ignore it. Both are terrible decisions and are the reason most traders can never successfully trade any strategy.
Pain is actually a signal and to ignore it is to suffer the consequences at your risk. Sometimes pain is necessary (like in the case in weight lifting). Just as in trading sometimes the drawdowns are a natural part of the market flow. But most of the time pain requires a response to mitigate and fix it. Ignoring it generally leads to only more pain down the road.
In trading this means that you must constantly examine and reexamine the underlying assumptions of the model and if possible make adjustments to current market conditions. This means that most strategies require constant tweaks in the form of filters. Just like a response to a twisted ankle is not to mindlessly soldier on, but to stop and bandage the area, so too a response to a drawdown is to try find an adjustment that can improve the performance.