One of the very worst things that can happen when you begin to trade a new trading system is to start losing right out of the gate. Just about anyone will tell you this occurs to them, “every time” (let me hear a big Amen). This tendency of human behavior is not just limited to trading a system you just found or created either. When I managed hundreds of client accounts, they would all pile in at certain times and leave at others that guaranteed they would lose. They did this with such remarkable accuracy buying my equity highs and selling my equity lows, it would amaze you. Why does this occur and how does one get the best (instead of the worst) of it?

When one is drawn to a trading program, it is because it is doing well. Never the opposite. Ever get an evening call from a broker in some boiler room in New York pitching you with a money manager’s performance that is losing, saying, “Mr. Prospect, this money manager has lost so much money recently, that if you come in with him now, you will surely be a winner?” I didn’t think so. So let’s recognize we are drawn to a new trading system or trading program at any given time because it is doing well. Step one to avoiding the inevitable is to track the trading program for a while to wait for it to not be at a new equity high.

It is simple; buy low and sell high. Maybe nobody ever told you that phrase applied to the equity curve on the money manager or trading system you were looking at, but the principle is solid.

On a trading system that trades the Emini S&P contracts or the SPYders shares etc. I would wait for a drawdown to occur that was average before entering. So you say to the broker, call me back when this money manager is losing, not winning (TIP: that might help to get the broker off the phone).

In the event I am already trading the system, and wish to add contracts for compounding, I use this simple rule of thumb: I wait to increase my equity enough to add a contract while the system is in a new drawdown from an equity high I benefited from. In other words, I will make enough on the system so that after drawing down from the high, I still have enough to add the new contract or shares. What this does, is it increases the probability I will not draw down while doubled up. This is also very important from a psychological stand point as well, because when your equity fluctuations double from having added new contracts or shares, it will likely be a bit unnerving at first; particularly if you are not up. This strategy helps to protect your earnings.

How do I get out of a trading system or money manager I am trading? I get out while I am ahead. If the system is making too much money too fast, it will likely implode, so it is best to get out while the going is really good. Oh yes, you might leave some good gains on the table at some point, but in the long run, this has always proven to be right. Look at any S&P or NASDAQ chart from late in the year 2000 and you will see what I mean. When the curve goes exponential, get out. Buy something that’s low, quiet and poised for growth.

These simple principles will serve you well, but it is hard to do. Grit your teeth and do the opposite of the herd as I have described above. Will it be a money management bonanza? Maybe. If you can stick with it, apply the above principles and manage your risk, I’ll will see you in the winner’s circle next year.