With broader diversification and better portfolio management, I am getting more and more close to avoiding from losing quarters. Yet, sometimes they can also come, and I must say that for me they have a positive value - I can always learn something new and motivate myself to work on further improvements and further testing of my ideas.

The unprofitable quarter itself is not a problem; it is something an experienced trader knows can come time to time - and it is necessary to reckon with it. Let me remind you that any trading approach in the world has its underperforming and unprofitable time periods - I have never heard of any strategy that wouldn’t have such periods (and from the nature of the markets, it is not even possible).

The sad moment comes when the trader realizes what he could have done in another, better way and quite often, with a little more advanced approach, could have completely avoided the losing quarter. What have I learned from some of mine, unnecessary losing quarters?

1) It is essential to control the overall profit of high-correlated strategies and also other strategies in the same group of markets

The biggest problem in one of my losing quarters was not the losses themselves, but the fact that in the losing day I had too many similar positions opened, from high-correlated strategies, and the loss for the day accumulated.

This experience led me to create something called GROUP HEAT. In short - to have a maximum risk amount set for all opened positions/strategies in given market group. By the market group, I mean strategies that are highly-correlated. For example, I can consider all my strategies for index markets to be such a group - because when there is a bad day for my breakout strategies in index markets, the loss is happening unnecessarily on too many fronts.

I was aware of the necessity of having GROUP HEAT already in the past, but, partially also from laziness, I have underestimated this step. Another reason was that when I was thinking about GROUP HEAT implementation, my index breakout strategies were doing well.

What is the definition of GROUP HEAT? It is a simple protection that checks that the total sum of stop losses of my currently opened positions in given market group is less than 3% of my current account (or any other value, depending on the size of your account and on your personal preferences). As soon as this limit for a group has been reached, no new positions will be opened.

This simple rule has helped me to save several unnecessary losing quarters or, at least, to reduce the losses dramatically.

2) I have learned that in the bad times I need to reduce the positions and in the good times to add up (to decrease the exposition when the strategy is in a drawdown)

From my previous tests and researches, I have found out that the best possible functional way in the bad times is to reduce my positions. Yes, the return from the drawdown is slower, but, what is more important, we protect our capital in the bad times and we don't let our whole portfolio go even into bigger drawdown.

Personally, I consider my strategies to be employees of my company: as long as they do a good job, they deserve more resources, a higher percentage of my trading account. When they do a lousy job, they deserve only a small percentage of my account.

So my trading approach in these situations is roughly following:

  • The deeper the system is in a drawdown, the lesser contracts you should allow it to trade.

  • As the system is getting back from the drawdown, you can slowly increase the number of contracts back to normal.

  • If you trade only 1 contract with each of your systems, consider temporary reduction of the number of systems.

  • I.e. systems with higher drawdown should have the lower priority over those that are performing well - and if there are bad times for the whole group (e.g. indexes), you should reduce the trading systems and the exposition in the given group, until the bad days for this group are over.

  • The last option is to increase or decrease the percentage of amount risked for every trade of a system. To do that you need to have a bigger account. The basic idea is again simple - the higher drawdown, the lower percentage of your account you allocate to the given strategy.

After lots of experiments, this philosophy has turned to work the best for me and has helped me many times in the weak quarters.

3) I have done a big mistake having too many long-biased strategies in index markets

The last reason for having losing quarters in many years of my life ATS trading was that I used to have in my portfolio much more long-biased index strategies then short-biased ones. Why? Simple because it is not so easy to develop a short-biased breakout strategy for index markets. The index markets tend to trend much more upwards than downwards so all potentially interesting short strategies have a small statistical sample of trades and that complicates its effective development and testing.

My experience from the past also showed that strategies with bias on one side are not a good solution. You need to build strategies trading both sides, or, at least, balance the long/short strategies in your portfolio - for every long-biased automated trading strategy you should find one that is short-biased.

If I have done that earlier, I could have saved some unnecessary losses.

I believe that when you take a moment to think about those 3 points described above, you will find out that they can help you to go through your bad times and improve your future trading results and stability of your profits.

Personally, I have paid quite a lot of unnecessary losses for these three lessons, but you can avoid them.

Happy Trading!



Author: Tom Nesnidal (more about me
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