October 2008: Learning from Adversity in the Markets

The week of October 6 was the worst trading week of my life and at the time I thought it might have been one of the worst weeks of my life period. I experienced first hand what was possible in the market during a bad time.

A recently as week earlier, I had hit new equity highs in all my accounts. I had actually come all the way back from the November 2007/January 2008 periods by implementing and sticking to a set of strong and steady trading systems. I was even starting to use some discretion because things were working so well (who says you can't predict the markets?). Life seemed pretty good, my confidence was high, although I admit some of the headlines were starting to bother me.

My account was starting to fill with positions, and my systems were calling me to scale into more positions. What happens next? The market after some fakes up, can't seem to hold any gains. I had seen this before, right? While it was happening I was scaling into even more positions and at points even bought into the market indices more broadly -- even to the point of using margin, much more than my own methods would allow for (instead of perhaps hedging the positions I already had given I was getting into so many). I had seen this before -- it was clear to me that the market was obviously coming back once everybody panicked and sold all they wanted to sell, right?

Well, we all saw what happened next -- this market goes on to post the worst week in history. In a span of five days, I lost over 22% of my accounts and everything I had worked so hard during the year to make and then some just vanished...and I still had exposure going into the weekend.

I was scared and sick to my stomach. I had feelings of guilt, despair, and emptiness -- you name the negative emotion, and I was experiencing it. I had reached the so called uncle point, that next Monday I started to divest myself of most of my positions.

Of course, within a couple of days, things start to come back with a vengeance, and I missed it out on it. I was even on the wrong side of the comeback on a few trades as I sold into the strength. You can imagine the thoughts that went through my mind -- I couldn't print them.

It was obviously time to regroup. There were times during the next week where I considered stopping, but after thinking it all the way through, I was determined to come back better for it. During the next week I calmed down, and started to replay everything -- review my trades, run my backtests to see if what I would have expected to happen actually happened.

One of the things I found during my review was had I followed my system without the massive overexposure, I would have experienced a drawdown of over 10%, but within a week or two I would have actually been at a new high again! Instead, since my emotions got the better of me, I abandoned what I knew was appropriate at exactly the wrong time. My whole strategy revolves around patience -- buying into fear and selling into greed -- and I was forced into doing just the opposite because of my own hubris.

The question going forward was: could I use this experience to learn from my mistakes?