Every trading system has drawdowns. Traders should address drawdowns in their trading plans and quickly recognize when to implement this section of their plan. You can use a Monte Carlo analysis to get a feel for the amount and intervals between drawdowns in your trading system. The method I use to manage drawdowns is to employ a "switcher".

The switcher signals me to stop live trading and begin paper trading until the market returns to a more favorable alignment with my trading system. To generate this signal I use data from my trading journal. On a X-Y scatter plot I graph my account balance after each trade (live or paper trade) on the Y axis and the trade number on the X axis. I then overlay a 2 week simple moving average (SMA) line. If the account balance is above the SMA line I trade "live" and if the balance is below the SMA, I trade on paper. The account balance will not be the same as your "real" account balance since the switcher keeps you out of the market during drawdown periods. To better visualize my trading system performance I also place a linear regression line through the data.


An example is attached.