How Does One Position-Size?

What is the singular most lucrative aspect of trading?

Any ideas?

Want a hint?

Ok, here’s the hint. It is also the safest aspect of trading.

Give up?

Here’s the answer. It’s called position-sizing. (The pioneer of position-sizing is Dr. Van K. Tharp, @ www.iitm.com, and I have learnt this concept through him).

Surprised? I would be surprised if you weren’t surprised.

Yeah, trade selection is important too, but other things are more important while trading.

For example, trade management is more important than trade selection. So is exit. Entry might be paramount to an investor, but to the trader, entry is run of the mill. It happens day in, day out. The trader … just enters a selected trade. There’s no deep thinking involved. The trader knows this. Crux issues are to follow. The trader is saving his or her energies for the crux issues.

So far, we’ve spoken about the chronology of a trade, i.e. entry – management – exit.

Before entry, you decide how much you want to trade with, and how much you want to risk. That’s the size of your position, or your position-size. Remember, for the concept of position-sizing to make any sense, your stop-loss percentage must remain constant from trade to trade. Only your traded value goes up or down.

What does the level of your traded value depend upon?

It depends upon HOW WELL YOU ARE DOING.

If you’re on a roll, your traded value for the next trade goes up. The increment is proportional to the profits you are sitting on. Since the stop is a constant percentage, the amount risked is also higher. Return is proportional to the amount at risk, and the long-term net return of such a trade will also be higher. All this means, that the more you make, the more you set yourself up to make even more…!

Take a coin. Flip it millions of times. There will be a stretch, where you’ll flip tails 5 times in a row, or six times in a row, or maybe even ten times in a row. The 50:50 trade called “coin flip” can well result in a series of back to back losses. You are an experienced trader. Your trade selection ratio could be 60 winning trades to 40 losing trades, or perhaps a little better, let’s say 65:35. Even a trade selection ratio of 65:35 will result in back to back losses. As a trader, you need to take large drawdowns in your stride, as long as you are confident, that in the long run,  your system is working. What’s working in your favour during the large drawdown?

Your position-size is.

You see, as trade after trade goes against you, and your losses pile up, your position-size KEEPS GOING DOWN. Your stop percentage remains constant. This means, that the more you lose, the more you set yourself up to lose lesser and lesser, trade after trade. Yeah, position-sizing gives you the safety of losing less. Nevertheless, because of this safety assurance from your position-sizing strategy, you keep yourself in the market by just taking the next trade without too much deep thinking (and with no melancholy whatsoever), because your next trade could be the one decent trade that you are looking for. Yeah, your very next trade could cover all losses and then some. TAKE IT.

Now, two things can happen.

Firstly, if you keep losing, and hit your loss cut-off level for the month, well, then, you just stop trading for the rest of your month. You then spend the rest of the month reviewing your losses and your system. You tweak at whatever needs tweaking, and come back fresh and rested the following month. Position-sizing kept you in the market, ready to take the next opportunity to earn big. The auto-cut takes you out of the market for a while. That’s why, in my opinion, while position-size is still activated, it provides more safety, because it keeps you in the market to recover everything and then some, starting with your VERY NEXT trade. Having said that, auto-cut is auto-cut. It overrides position-sizing.

The second thing that can happen is that your losing streak ends before your month’s cut-off is reached. Yayyy, position-sizing is still activated! You’ve lost lesser and lesser on each losing trade as long as you were in the losing streak, and now that you are winning again, each win sets you up to win more in the trade that follows.

After many, many trades, just cast a glance at your trading corpus. It will boggle your mind!

Your position-sizing strategy has kept raising your corpus, because your system is 60:40+, and you win more than you lose. Ultimately, your corpus has become substantial. Its size exceeds your expectations BY FAR.

All thanks to position-sizing.

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The Cat that Survives Curiosity

So, what are the Joneses upto?

Or the Smiths?

Naths?

You know something, who cares?

You’re trading, right?

Fine, then just mind your own business, and focus on your return.

I mean, people, let’s just go beyond poking our noses into others’ businesses.

Don’t we have our own businesses to take care of?

Isn’t that enough for us?

If not, and if we start poking around, seeing what kind of return XYZ has made, or for that matter how many winning trades ABC has pulled off, well, we are doing ourselves a great disservice.

For starters, we don’t seem to have much confidence in our own trading system, if we’re poking around like that.

You should be pulling off the winning trades, you.

And XYZ’s or ABC’s performances should have no meaning for you.

They are trading according to their system. Let them be. What’s good for them is not necessarily good for you.

You are trading according to your system. Period.

Not minding your own business can seriously affect even a successful system which has temporarily hit a string of losing trades.

Random losses in a row happen. A winning system can well yield ten losses in a row, for example. Improbable, but not impossible.

Ask a coin, which functons at 50:50. On average, you’re flipping heads and tails equally. Nevertheless, you could land heads (or tails) ten times in a row over many, many coin-flips. Part of the game. Accept it.

Since you have a system, you’re functioning well beyond 50:50, right?

Thus, chances of a large number of losses in a row are even lesser for you.

Tweak at your system if you feel it’s lost its market-edge.

To remind you, an edge starts occurring when one functions beyond 50:50.

After a while, one gets bored, and tells oneself, that from now on, one wants to function at 55:45 and beyond (for example), come what may.

One then tweaks at one’s system, and raises the bar.

Tweak at your system if you feel the urgent need to raise the bar.

Keep raising the bar to your comfort level.

Leave other people alone. Don’t bother with their systems. Focus on your own trading.

Be the cat that survives curiosity.

Coin-Flipping in the Marketplace

Are you good at darts?

Actually, I’m not.

I’ve even removed all darts from our home. Hazard. Children might hurt themselves. Yeah, yeah, I know, I’m paranoid. Tell me something new.

Well, just in case you fancy playing darts, here’s a market exercise for your consideration.

Take a newspaper section, and pin it on the wall.

I know, I know, you’d love to take pot shots at your favourite corrupt politician’s picture. Please feel free to do so, let out all your venom. When you’re done, we can resume with the market exercise.

Now substitute whatever picture you’re shooting darts at with the equity portion of your newspaper’s market segment.

Take a dart. Shoot.

You hit some stock or the other. Let’s say you hit XLME Systems.

Now take a coin. Flip it.

Go long XLME Systems if you flip heads. Short it if you flip tails.

You have a 50:50 chance of choosing the correct trade direction here.

This is still a winning system, if you manage your trades with common-sense.

Cut your losers short, quite short, yeah, nip them in the bud. Let your winners ride for as long as you’re comfortable.

These two sentences will turn your little darts cum coin exercise into a winning market system.

Try out a 100 such trades, coupled with proper, common-sensical trade management. You’ll see that you are in the money.

Now, whoever turns towards me and starts to talk about trading systems, well, that person needs to be very crystal clear about one thing.

He or she needn’t bother discussing any trading system with worse results than the above-described trading system.

I mean, come on, people, here’s nature, already presenting something to us which doesn’t require any formal education, just an average ability to aim, fire, flip, trade, and manage with common-sense. This small and natural system is enough to keep us in the money.

So, if we want to spend any time discussing trading systems with an edge, we need to be sure that these systems are functioning at beyond 50:50. At par or below is a waste of time.

Good trading systems with a market-edge function at 60:40.

In the Zone, you maneuver your evolving edge to function at 70:30 and beyond.

Frankly, you don’t need more. You don’t need to function at 80:20 or 90:10. Life at 70:30 is good enough to yield you a fortune.

Getting to 70:30 is not as difficult as it sounds. First, get to a 60:40 trading system. Out of every 100 trades, get the trade direction of 60 right. Comes, takes a bit, but comes eventually.

Now you’ve got your good trading system with a decent edge, it’s working at 60:40, what next? How do you extract that extra edge.

Well, tweak. Adapt. Fine-tune. Till your edge becomes that something extra.

Still want more?

If yes, the game becomes a story about you. How disciplined are you? Are you with the markets regularly, as a matter of routine? Are you with the flow? Can you sense the next move? Are you slipping into the Zone? Can you stay in the Zone for long periods? Once you slip out, can you get back into the Zone soon?

The answers to these questions lead you to 70:30 and beyond.