I’ve come to the realization... that trading defensively is really the right approach for longevity as well as keeping your cortisol levels down. Protect both your monetary capital AND mental capital with a systematic plan. Just like in sports where they say, “defense wins championships”, in trading, I believe you need to do it for sheer survival. Consider the following scenario, you have a 90% win rate on average and you usually do say 1000 shares per trade. This means 9 out of 10 trades you made are winners. So after awhile you realize, “hey, 90% win rate? I can probably “size the fuck up”.” Here’s the problem with that. Although trading is a game of probability and 9 out of 10 is undoubtedly great. What would happen if you were caught with size and were just simply unlucky enough to get stuck with a catastrophic, black swan type event just that ONE time. After all, we already know all it takes is ONE epic fiasco and you’re done. What if you were long something, all in, and got stuck in an intraday halt-gap down or offering dump out of the blue? What if you were short and got stuck in a dilution cancelling news or buy out? The market doesn’t give a shit about your tape reading or chart reading skills here nor does it give a shit about whether or not this was your A+ setup. If it wants to fuck you over, it will fuck you over at it’s whim. Are you prepared to take a huge loss that would wipe out a sizable portion of your account and thereby basically negating what seemed to be a 90% win rate? Oh and anyone that claims they can foresee all of these potential debacles beforehand every single time? I respectfully have to say they’re full of shit. Again the key here is, you only need ONE of these are you’re done, which means although probability is the name of the game here, we still have to account for that ONE time that could wipe you out. Even a 99% win rate setup, could end your career theoretically if you decided to “go for it” and were that unlucky bastard to get stuck in that 1% doomsday scenario. Ask yourself, is that something you’re willing to risk?
So how do we prevent this? By keeping the size, reasonable and fairly constant. This allows you to put, more or less, equal weight to each of your trades and thus no ONE trade will ever take you out. Here’s an example. Keeping the numbers easy again, if you did 1000 shares every time no matter what and 9 out of 10 trades are winners. Say you average 50 cents on your 9 winners so you make $500 each time and you’re up $4,500 total and let’s just say on the 10th trade you lose and it’s an absolute doomsday, black swan scenario. You short a stock at $2 and it blows through 3 resistances at $3, $4, $5 and you were too deer-in-the-headlights to stop out and you don’t get out until $6. Shitty situation right? Although I trust most of you wouldn’t hold a short down 300% as that is just horrendous risk management, even in this terrible scenario if you stuck to your original sizing parameters and did 1000 shares, you’d lose $4,000 and still actually be net green on all your trades. Hell, even if you let it go a few more dollars, you’d only be red relatively small and definitely not “blow up” territory. But imagine if started thinking you were hot shit and decided to go for it on that trade and went 10,000 shares instead of the usual 1,000. I don’t think I have to run the numbers for you there. Next point, we need to keep in mind also the following (there’s approximately 250 trading days in a year): $250/day = $62,500/yr $500/day = $125,000/yr $1,000/day = $250,000/yr $2,000/day = $500,000/yr $3,000/day = $750,000/yr $4,000/day = $1,000,000/yr In the myriad of huge P/Ls that we see in the twitterverse (myself included), one thing I eventually started pondering is there really any reason to take such ridiculous risks and go for massive wins if in the end all you need to do is make $4,000/day to hit the million dollar mark on an annual basis? (I made $1,700 today and my largest position was 1,250 shares.) Your favorite twitter trader that posts those $50,000 P/Ls, probably isn’t living in a $100,000,000 beach front mansion sipping on champagne while averaging $50,000/day or making $12,500,000/yr. They’re taking huge risky trades that could one day take them out of the game if they were unlucky enough to get stuck in a black swan event. The big days will come naturally. More fluid and predictable action will offer more opportunities which means more profits without having to take a huge gamble.
The Resolution
So here’s my approach moving forward. I’ve identified that I’m basically almost green every time at the open (well over 90% of the time), with the open being defined as the first 10-15 minutes. Even on the days where I suffered massive losses, I was usually still up nicely at the open. I was up +$5.4K on the day I lost -$70K on BLNK and I was up +$5.1K on the day I lost -$40K on BLNK and I was up +$300 on the day I lost -$27K on $HEAR. This clearly means the edge dropped off substantially, at least from my personal observations, after the open. This clearly means one thing needs to be done here: DOWNSIZE. Understanding the edge is lower after the open, you simply cannot apply the same weight to those trades, as good as they may appear to be. This will help mitigate the effects of nonsensical and unpredictable price action. I’m going to be instituting a strict tiered sizing system that will achieve exactly this and it’s very simple.
Normal-size only at the open for the first 10-15 minutes. Half-size from 10-15 minutes to about 30 minutes into the day. Quarter-size from that point on. 10AM EST-11AM EST is walk away for #TraderNap time barring the presence of an epic and easy-trading, fluid squeezer The idea here is to take advantage of the high edge open, take the quick win then if there’s a trade after that, going in half size will help protect profits by making it so that you have to get stuck in a move that is twice as big as your first win in order to lose those profits. For example. if you’re in 1000 shares as your normal size and you make 50 cents on your first trade. Then on your second trade take 500 shares, and you would have to lose $1 per share in order to lose those gains from the first time. In most cases you would probably stop out before you lose that much on a per share basis but this is just to protect should a bad situation come up. The process is then repeated after that with half of half size which is a quarter size.
The idea is to protect profits so that way you don’t fall into the revenge trading trap and we know how devastating that can be. Even if you LOSE on the first trade, you still need to stick to sizing parameters. The market doesn’t care whether you made or lost money on the first trade and it isn’t going to magically give you a 2nd “make up” trade of equal quality to make it back, so you can’t full size your 2nd trade just because.
By having a set sizing system it also allows you to not arbitrarily apply size randomly on the fly based on “gut feeling” which may lead to irrational thinking where greed and other emotions will most likely cloud your judgment. How many times have you decided to take a midday trade that looked good on paper? Everything seemed to check out and you go for it with size and it ends up being the infinite dumper that you’re in long or the infinite grind squeezer and you’re in short? Once the action starts getting choppy, grindy, sketchy, or dead, you leave, whether you’re UP or DOWN. As for account size, I’m going to stick with a $30,000-50,000 account for the rest of the year and will be wiring out everything in excess of that. I’ve proven time and time again that I can pull off a $5,000 or even sometimes a $10,000 day in great market conditions with that account size and there’s no reason to give myself the temptation of pushing huge size again with a large account to start this vicious cycle over again. At this point I feel like a larger account does a lot more harm than good. Always pay yourself and wire out when you can to truly turn those realized gains into real money instead of just remaining a number in your account.
Losses are inevitable and they will happen but we must work to mitigate their impact on our accounts. Having set, strict sizing parameters will help ensure the integrity of your trading statistics and help you stay in the game for life.
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