Drawdown Psychology
How to Survive and Thrive When Markets Test You
"If you can keep your head when all about you are losing theirs…" - Rudyard Kipling
Every trader, whether dealing in stocks, FX, options, or futures, will eventually face the dreaded drawdown. It's an inevitable part of trading, yet when you're in one, it can feel like the sky is falling.
In this article, I’ll break down trade-level drawdowns and portfolio-level drawdowns (the peak-to-trough equity declines of your portfolio). I’ll explore the unique psychological demons each scenario awakens and strategies to conquer them.
You'll learn how to handle the fear and frustration they cause, and what tools seasoned traders use - from risk management rules and journaling practices to mental frameworks — to stay in the game. Along the way, I’ll touch on key behavioural biases (like loss aversion, the sunk cost fallacy, and decision fatigue) that make drawdowns so challenging, and share a few of my own war stories and hard-learned lessons from real trading experiences.
The tone is direct and honest, coming from someone who's been scarred by the markets and lived to tell the tale. Whether you trade equities, FX, options, or futures as a retail lone wolf or a professional with clients to answer to. The goal here is to equip you with a survival guide for the inevitable ups and downs. Let's dive in.
The Psychology of Trade-Level Drawdowns
When you're in a trade and it starts going against you, the psychological pressure can be intense. Intra-trade drawdowns trigger a cascade of emotions and biases in real time. Let's paint the picture:
1. The Emotional Rollercoaster of an Open Trade
Imagine you bought an FX pair (say EUR/USD) at 1.1000. Shortly after, it slips to 1.0950. You're now 50 pips in the red. Your heart rate picks up a little. You start second-guessing the trade: Did I misread the chart? Should I cut it now before it gets worse?
This is the feeling of a trade-level drawdown – that knot in your stomach as you watch an unrealised loss grow. Every pip against you feels like it's poking at your fear of being wrong. Loss aversion kicks in hard here: studies show we feel the pain of losses about twice as strongly as the pleasure of equivalent gains. That means a $5,000 unrealised loss hurts as much as a $10,000 gain would please you.
2. Fight, Flight, or Freeze – Common Reactions
People typically react to an intra-trade drawdown in a few unhelpful ways. One is the "fight" response: you might add more to the position to lower your average cost (also known as "doubling down" or martingaling), trying to fight your way out of the hole.
Another is "flight": you panic-sell to cut the pain short, often just before the price turns (we've all been there – you exit in fear, only to watch the trade would have worked).
The third is "freeze": you do nothing, paralysed, or worse, you refuse to honour your stop loss because you "just can't take the loss." Freezing often leads to the loss getting much bigger than planned. This is where the sunk cost fallacy seeps in: you've already lost some money, so you irrationally hold on even longer, hoping to "get back to breakeven," as if that will redeem the initial loss. In reality, you're just risking more in hopes of not feeling like a loser. If you catch yourself thinking, "I'll sell when it gets back to my entry price," that's a red flag of sunk cost bias and anchoring to an irrelevant reference.
3. Ego and Identity
On an individual trade, especially for experienced traders, there is often a battle with one's ego. You did your analysis and put on the trade with conviction – now the market is telling you (in the form of a floating loss) that you were wrong, at least for now. For some, this feels like a personal indictment.
The need to be right can override the objective decision of cutting a losing trade. You might move your stop further to "give it more room" (usually just giving it more room to hurt you). Or you avoid placing a stop at all, telling yourself you'll manually exit if it gets too bad (only to hesitate when that moment comes). Pride sadly has no place in trading, but it has a habit of sneaking in when a trade goes south.
4. The Mental Toll of Watching the Screen
The minute-by-minute stress of watching a trade in drawdown can really take its toll. It's a form of torture by a thousand cuts – each tick down is a new cut.
You start imagining worst-case scenarios ("If it drops another 100 points, I’m fucked!”), which adds anxiety. In this state, decision fatigue sets in quickly; your ability to think rationally and stick to your plan erodes with each passing minute of stress. Neuroscience tells us we have a limited capacity for making disciplined decisions in sequence – after just a few tough choices, our self-control can evaporate. If you've been manually managing a losing trade for hours, your willpower tank is likely near empty, which is when impulsive mistakes (like a reckless all-in or abandoning your strategy) are most likely.
The Psychology of Portfolio-Level Drawdowns
Trade drawdowns are the day-to-day scuffles, but portfolio-level drawdowns are the full-on battles that test your fortitude. A portfolio drawdown means your account equity has fallen from a prior high, and until you climb above that high, you're in a valley. If you trade long enough, you'll have plenty of equity curve valleys. Let's talk about what happens in someone’s mind during those slumps and why they're so challenging:
1. The Weight of a Losing Streak
Unlike a quick hit on a single trade, a portfolio drawdown often accumulates over a series of positions. Maybe you had five losing trades in a row, or one really bad trade followed by a couple of small gains and then another big loss. However it happens, you look at your account balance and it's down significantly from its peak.
This is when self-doubt comes flooding in. You just start questioning everything: "Has my strategy stopped working? Was my recent success just luck? What if I never get back to my highs?" It's not just about the money lost; it's about what that loss means to you.
Many traders equate their account's equity curve with their competence or even their self-worth. So a 20% drawdown in the account can feel like a personal 20% drawdown in confidence. Indeed, drawdowns make you ask, "Am I losing my touch?" Our minds are pattern-recognition machines, and during a drawdown, we often see a phantom pattern of "I'm a failure" even if, objectively, a string of losses can happen to the best of us.
2. Loss Aversion and Fear in the Big Picture
Behavioural finance tells us that humans are generally risk-averse when winning but become risk-seeking when losing – we hate losses so much that we'll take irrational risks to try to avoid or recover them. In a portfolio drawdown, this can manifest in two extreme ways:
(a) The Panicked Turtle: You become so afraid of losing more that you retreat into your shell. You might stop trading altogether or dramatically cut your position sizes out of fear. You pass on valid setups because you're traumatised by the recent losses. This is driven by loss aversion – you're overly focused on not losing any more, to the point that you stop executing your strategy properly. The irony is that this can lead to missing good trades that would have helped you recover.
(b) The Desperate Gambler: On the flip side, some traders react by doubling or tripling their risk in an attempt to win it all back quickly. If they're down 15%, they figure one or two big gains with heavy size will fix it. This is the loss-chasing mentality, and it's extremely dangerous. It's what Ross Cameron described as "emotionally capitulating" – the moment you say "screw it, I have nothing left to lose" and start taking giant bets as a last stand. That mindset can lead to catastrophic losses that blow up accounts. It's basically gambling with a tilted emotional mindset.
Both the turtle and the gambler responses are rooted in the pain of drawdown and fear of further loss. Neither is healthy for your long-term survival.
3. The Sunk Cost Spiral
The longer a drawdown drags on, the more susceptible you become to the sunk cost fallacy on a grand scale. You've invested so much time, effort, and money in markets – maybe years of work – and now it feels like it's slipping away. Instead of stepping back to objectively reassess, many dig in deeper.
It's like being in a hole and deciding to keep digging because you refuse to climb out and start fresh. You might keep trading a failing strategy because "it worked before, it has to work again" or because you can't bear the thought that all the gains you had are gone. In reality, if a strategy genuinely stopped working due to a market regime change, the rational move is to stop or adapt. But in a drawdown, rationality is in short supply.
Traders often refuse to acknowledge that what they're doing isn't working, turning a multi-month drawdown into a multi-year one. Sunk cost thinking makes you hold on to hope and positions long past their expiration date, simply because you "have so much invested in them." It's the same reason a gambler keeps feeding money into a losing game – "I've come this far, I can't quit now."
Recognising this bias is critical: sometimes the correct (if painful) move in a deep drawdown is to hit the brakes, preserve capital, and accept that you need a new approach.
4. Ego and External Pressure
A portfolio drawdown can be a public affair, unlike a private little intra-trade wobble. If you're a professional trader or manage money, a drawdown might mean explaining to clients or bosses why your book is down. Even if you're a retail trader, you might feel the need to "prove" to your spouse or friends (or yourself) that you're a good trader, especially after a hot streak.
A drawdown can feel like a humiliation or an identity crisis. If you pride yourself on being a winning trader, a big slump dents that pride. Ego defence mechanisms then kick in. Some traders become very averse to booking the loss and officially marking the drawdown "closed," because that feels like accepting defeat. There's also a tendency to isolate oneself during drawdowns out of shame, which can make things worse since you lose perspective.
Remember the stories of famous fund managers: even the greats like Paul Tudor Jones or Warren Buffett have had significant drawdowns or periods of underperformance – the difference is they acknowledge them and stick to their principles (or adapt) rather than denying the reality.
The point is, drawdowns happen to everyone; it's not a moral failing. But our ego tends to tell us, “If I were truly good at this, this wouldn't be happening." That thought is poison.
5. Fatigue and Burnout
A prolonged drawdown is like a slow bleed. Day after day, seeing little to no progress back to highs can drain you mentally. This is where ego depletion (decision fatigue) can really wear you down. Each new trade during a losing streak takes a heavier mental toll than the last, because you're carrying the baggage of previous failures.
Over weeks, this leads to exhaustion, and exhausted traders make mistakes. You might become careless or start taking trades outside your strategy because you're just sick of being down and want to force a turnaround. Or, you become so gun-shy that you hesitate on great setups. Both are costly.
It's important to recognise the duration of a drawdown as a factor, not just the depth. Research has highlighted that the length of a drawdown can erode confidence just as much as its size. A 5% drawdown that lasts six months can psychologically feel worse than a 15% drawdown that you recover from in two weeks, because the long grind is mentally taxing.
Participants often underestimate this. You need to monitor your own energy and focus levels in a slump; otherwise, you risk sliding into a state of burnout where you either make a huge error or you just lose passion and quit at the worst time.
6. A Portfolio Drawdown Story
Let's say a retail trader, Hound, built his $100k account up to $150k over a great year. He's feeling on top of the world. Then the market conditions change – say, vol spikes – and his strategy hits a rough patch. In the span of a month, his account goes from $150k down to $120k. That's a 20% drawdown from the peak (awful risk management, but this is purely fictional).
Hound is devastated. He hadn't experienced a downturn like this before. Initially, he reacts by halving his trading size, scared to lose more. A couple of trades win, but in smaller size, so the equity curve barely ticks up. Frustration builds.
He then decides, "I guess I just need one big trade to get me close to back." He goes heavy and over his risk parameters on a setup he's only semi-confident in. If it works, he could make $15k and be almost out of the hole. If it fails... well, he doesn't want to think about that.
Unfortunately, the trade fails. Now his account is $100k – he round-tripped an entire year's gains. At this point Hound capitulates emotionally. He takes a few revenge trades, swinging from the ropes (sunk cost fallacy fully engaged – he can't accept having wasted a year). When the dust settles, Hound’s account is $90k.
This is a drawdown far deeper than his strategy ever should have risked. It wasn't the market alone that did this – it was Hound’s compounded psychological reactions to the initial drawdown. This kind of downward spiral is sadly common. It illustrates how a moderate drawdown can escalate to a ruinous one if not managed well.
Strategies for Managing Portfolio Drawdowns
Many of you might have had a rough year… If you find yourself in a drawdown in your overall account, here are some strategies and tools to regain control and work your way back prudently:
Stop the Bleeding – Reduce Risk
You saw me do this recently!
The first rule of handling a drawdown is don't dig the hole deeper. This often means scaling back how much you're risking on each trade until you get your rhythm back. Many professional traders and funds have rules like: if drawdown exceeds X%, cut position sizes by Y%.
For example, one trader mentioned having a personal threshold: at 15% down from his high, he would drastically reduce his risk per trade, and if he hit 20% down, he'd stop trading entirely to reassess. This kind of rule is a lifesaver.
It's counterintuitive to some (because when you’re down, you want to make it back faster), but think of it this way: if you're driving and start skidding on ice, the last thing you do is hit the accelerator. You ease off and regain control. In trading, when you're skidding (equity heading south), trade smaller.
By cutting your risk per trade in half (or more) during a drawdown, you ensure that any further losses have a minimal impact while you troubleshoot what's going wrong. It also calms you psychologically, because you know you're not going to implode your account with one more bad day. Only once you've strung together a few gains or see evidence you're back in sync should you consider scaling back up. Think of it as trading with a safety net until you're performing well again.