Risk On, Risk Off
One of the “secret sauces” to successful long-term trading is the ability to smartly adjust my position sizing to better take advantage of opportunities.
Feels like I'm often thinking to myself that my losing trades were position-sized too large, and my winning trades were position-sized too small. That will always feel true. Makes sense. But I don't have a crystal ball to know ahead of time which trades will be the winners and which will be the duds. And I can’t go back in time to change my decisions.
So what can I do to increase the odds that I win bigger and lose smaller?
The simplest way is to risk the same percentage of my account on every trade — say 50 basis points (half of 1%) of my total risk capital. In this scenario it would naturally lead to my position sizes increasing when I’m winning (because my capital base is rising), and conversely, my positions shrinking during losing streaks.
This is a perfectly acceptable risk management strategy. But maybe not the best. I don’t believe there is a “best.”
Another way is to systematically add to my winning positions. When I get into a trade and it starts working, I can add more units (shares or options contracts) as my open profits continue to build in the trade. Some call this pyramiding. Whatever you want to call it, it can lead to some monster wins when I get a hold of a good trend. But these positions become harder and harder to hold as my PnL volatility increases with each additional unit. It takes some stones to sit through normal pullbacks that might feel exponentially worse to me due to my larger-than-normal position. Easier said than done.
A third way to increase my odds of winning bigger and losing smaller might be to only position bigger from the start when I’ve got a PnL cushion giving me a position of strength. This probably makes more sense if I was day trading. Basically, the thinking here is as my intraday profits pile up, I may risk my normal amount + some percentage of my current daily gain. For example, let’s say I’m usually risking $500 per trade; at midday, I’m currently up +$1,200 on the day. Maybe I’m willing to risk 25% of my open profit in addition to my normal risk. In this case, I’d risk $500 + (.25 x 1,200) = $800.
This is not an exhaustive list of ways to alter my position sizing, but it is three common approaches I use and I hope it may spur some brainstorming on your end to help you level up your risk management game.
What works for you? Please tell me about it!