“I don’t know a single trader who hasn’t either blown up an account or had a way-too-significant drawdown on an account,” equities trader Erik Smolinski, who has returned 25% a year on average for the past five years and 52% in his best year, told Insider.
The 32-year-old got an early start investing, thanks to a high school teacher who encouraged him to put his savings to work.
His one formative mistake happened in college. At that point, he’d been trading options for five years and was a little overconfident.
One trade was a short iron condor, which is an options strategy where the trader collects a “credit” up front, he explained: “This represents our max profit potential. The goal of these trades is for the underlying to expire between a range. These are generally high probability trades, where we have a lower profit potential with a higher probability of making that profit.”
It was a four-day trade and, “I completely forewent any true risk management analysis,” he said. “What that means is, even though the probabilistic outcome of the position is whatever it is when you first put it on, it changes. Information changes, everything changes. So, I didn’t fully respect how the underlying could have moved and did move while I was in the trade.”
A couple of days into the trade he was heading to the gym for a workout and opened the trading platform on his phone.
“I see this insane drawdown on my entire portfolio,” recalled Smolinski. “It was a mid-30% drawdown. It was massive — on one single trade. And I just remember looking at it and digesting what was going on. I looked at it in the parking lot first and then I looked at it again when I got into the gym, and then I closed the trade. I was just like, ‘Okay, this has gotten way out of hand. I don’t know what’s going on. I need to stop the bleeding so I can figure it out.'”
It was the largest percentage drawdown he’d ever seen on his account. The dollar amount he lost wouldn’t be significant today — he now has a seven-figure account, which Insider verified, and a diversified portfolio that includes residential and commercial real estate — but, at the time, “it was a huge amount of money for me,” said Smolinski.
The experience taught him about the Dunning-Kruger effect, which is essentially when someone overestimates their own competence.
It can lead to a “dramatic overconfidence and also lack of analysis of what we’re doing,” he said. “That’s a really, really dangerous point for all traders: When you first start, you don’t know anything and you know you don’t know anything; then, you spend a bunch of time and effort learning; and now you think you know something but unfortunately, you still don’t know what you don’t know.”
For traders specifically, that can expose them to risk they don’t acknowledge or even understand is there, which is what happened to Smolinski.
Ultimately, Smolinski’s mistake, which he categorizes as the “most pivotal moment in my trading career,” forced him to reevaluate his trading proficiency and strategy. “It taught me more than I ever could have read. Most traders have to touch the stove themselves before they realize it’s hot.”
Reevaluating his strategy and getting ‘super organized’
Smolinski didn’t have a trading plan up until his first big loss.
One of his mentors had been encouraging him to produce one but he didn’t know where to start or what to put in his plan. Plus, “it sounded like a lot of work,” he said, adding, “I was trying to make money fast.”
However, his account drawdown prompted him to create a blank Word document and start his trading plan, which has grown to 388 pages.
His trading plan, which is broken out into various sections and includes “strategy outlines,” serves two main purposes: First, it forces him to think through various scenarios so he has a roadmap if and when things don’t go as expected. Secondly, it helps him make the best decisions without letting his emotions be in charge.
That’s where his trade log comes into play, which is a different document and where he keeps the data he’s collected from trading for so many years.
His documents took a lot of upfront effort to build. The time commitment at first “is massive,” he noted. But now they work in tandem to create structure — and, at the end of the day, an organized trader will be able to see what works and what doesn’t work.