What Size Where?-photo by AJ Mallari
If there is one thing that made wake me up to the fact that I was Trading wrong, it’s Position SizingTM. I picked this up from “Trade Your Way to Financial Freedom” by Dr. Van Tharp (who owns the Trademark -hence the TM- for it). He notes “the concept of Position SizingTM is one of the two key factors you must master if you want success in the market”. And for me, staying alive. 😛 (The other key factor is Psychology or what I prefer calling Self-Mastery).
Position SizingTM as we’ve talked about earlier answers the question “how much” we are risking per trade.
Let’s review:
- This “how much” is NOT the amount you are using to buy your shares , this is the amount you are willing to Risk or “lose” per trade.
- You decide on this before doing anything, small enough to keep you trading and big enough to have a worthwhile profit from an opportunity.
- 1% to 2% of capital should let you trade comfortably. Position Size is expressed as a percentage of your capital.
Let’s bring back the previous example in Learn to Last – Financially
Say for example, you have $5000, you want to preserve 80% of your capital or $4000, you then have 1,000. Of this 1000, you want to budget for a string of losses (say 10) which will give you $100 to risk in a position. (Fees are excluded here for simplicity but note it could cost $45 to open so $90 to open and close the transaction – for Options).
5,000 capital
4,000 amount to be preserved, at 80% of capital
1,000 amount to be risked at trading opportunities
10 number of successive losses you are willing to tolerate
100 the amount you will risk in a position
$100 or the 2% of $5000 is your Position SizeTM
NOTE : In the Trading Process to be discussed later. We will also refer to your Position Size as 1R – R for Risk – 1R for the first amount you will be risking.
You may want to check Dr. Tharp’s e-learning resource for this very important topic.
http://www.vantharp.com/products/Position-Sizing-Elearning-Intro.asp
_________________________________
Two Things to Think Through
In Trading, I said earlier, you first need to Learn to Last. Survive.
When you’ve learned enough to stay alive, the next thing is to learn to grow profits. Thrive.
You should have different Position SizingTM to meet these Objectives.
I confess, before I knew all about this, (and sometimes after I’ve learned it), I’d vary how much I’d spend on trading based on what I think is my “need” for profits. WRONG! It’s a sure way to losing it all. (I should know!) I really didn’t have a strategy. I didn’t think I needed it. I didn’t find this in broker’s educational resources or trading seminars. Anyway, you might bump into “Money Management” but that is just a wee bit related – talking about how to allocate money to what you will buy etc. But not for every trade. It’s not the same thing.
Survive – take baby steps
Looking back at that (painful) experience one of the lessons apart from that I didn’t know position sizing or a strategy to stay alive for that matter, is that I traded with big amounts (for my capital). I absolutely recommend you trade small as you start. You are just learning at this stage. You might think,”I’m going for it”. “I’ve got big dreams that I want to achieve”, but girl, all that will come later. I also suggest to think that you will have a string of losses, from the example above, use 10 consecutive losses. It can absolutely happen, plan for this so you can keep trading.
So for the first trades, like “baby steps”, go slowly, one foot first, then put the second foot in front. When you first start trading, just open one position, on one stock (or whatever you are trading). Monitor and close that first, do not open another trade while that one is in progress. Multiple positions can confuse you, (I sooooooooo know this!) Just keep going along one trade at a time.
You budgeted for 10 losing trades, when you get to half (after 5 trades) and you haven’t won anything, I suggest you STOP actual trading and paper trade or practice again. You could still lack some technical knowledge and/or discipline. When you have good results with practice trading (e.g. back to your old capital), resume trading, but remember now you have less capital. You can elect to stay at 2% or lessen that to 1% but that is not likely to be profitable given your capital. Don’t try and recover what you lost with BIG position. There is no guarantee it will be a winner, you could burn a bigger hole.
Now you might be thinking at this point, what if I still keep losing? Actually, I use a Covered Call Options strategy with this Position SizingTM so I don’t lose as much and remain in the business. Mentioned this in “Learn to Last-Financially” and will discuss it more later at the Trading process (building the suspense! 😛 )
Thrive – step up!
Thrive - photo by AJ Mallari
Eventually you will get to the point where you’ve grown your capital. (Think positive!). If you are above 40% from original capital, in our example the $5000, thus you now have $7000, that’s a good place to increase your risk. I suggest the following adjustments :
- Increase from overall capital, say your $5000 became $7000 – 2% of that is $140
- Increase from profits only, say your $2000 profit, use 10% of that which is $100 to add to your original position sizingTM $100 (the 1% from $5000) for a new position size of $200 (2.85%)
It’s up to you what to use. I use the second option just because I am more comfortable knowing I only spend my profits, keeping track of original investment that I may want to use for other investment later. Remember the Infinity concept?
The increased position size will help you to multiply your win. Think instead of the 100 x $1 shares, you have double that now, having 200 x $1 shares. With the same effort, you are multiplying your income. Isn’t that exciting?! Step Up! Step Up! Step Up!
(Position SizingTM is a Trademark of Van Tharp Institute / Dr. Van Tharp
