Van Tharp:
Have you played around with any other significant ideas in terms of position sizing besides market’s money? If so, what are they?
If you could give me ten rules to consider with respect to position sizing what would they be?
Ed Seykota:
“Playing around” with “when market money becomes your money” seems to be an exercise in math-turbation.
I don’t know what you mean by playing around with ideas. I feel you either think things through or you don’t.
Ten rules for position sizing:
1. Bet high enough to make meaningful profits when you win.
2. Bet low enough so you are ok financially and psychologically when you lose.
3. If (1) and (2) don’t overlap, don’t trade.
4. Don’t go adding a bunch of rules that don’t work, just so you have ten rules.
Archives of “position sizing” tag
rss10 Points For Successful Trading
Trading Methodology:
- Winning system-Only trade tested systems with a positive expectancy in the long term.
- Faith– Your system has to allow you to trade your beliefs about the market.
- Risk/Reward-Never trade unless your profit expectations are greater than your capital at risk.
Trader Psychology:
- Discipline-You have to keep trading your method even when it doesn’t work for a given time period.
- Ego-Admit when you are wrong.
- Emotions-Trade the math not your emotions.
Risk Management:
- Risk of Ruin-Never risk more than 1% of your total account capital on any one trade.
- Position Sizing-Use your capital at risk to understand the right amount to trade based on the securities volatility.
- Capital at risk: Never put more than 6% of your total capital at risk at any given time on all positions.
- Trailing stops- Always have an exit strategy to lock in your winners.
Speculation -Defination
Speculation by definition requires some amount of loss otherwise the game is fixed. However, I believe loss can be broken down into avoidable loss and unavoidable loss. Unavoidable loss is, well, unavoidable. But in my personal experience (and based on pretty much all speculative loss I have seen or read about) all avoidable speculative loss is traced back to some core elements/violations: not being disciplined (many interpretations), getting emotional and all of the associated errors and mistakes that brings, sizing positions too big so that regardless of odds you eventually have to reach ruin, not being consistent in your approach (the switches), not managing your risk adequately either via position sizing or stop losses, finally you have to be patient for the right pitch whatever that may be for you.
10 characteristics found in Best Traders
- They all have a tested, positive expectancy system that’s proved to make money for the market type for which it was designed.
- They all have systems that fit them and their beliefs. They understand that they make money with their systems because their systems fit them.
- They totally understand the concepts they are trading and how those concepts generate low-risk ideas.
- They all understand that when they get into a trade, they must have some idea of when they are wrong and will bail out.
- They all evaluate the ratio of reward to risk in each trade they take. For mechanical traders, this is part of their system. For discretionary traders, this is part of their evaluation before they take the trade.
- They all have a business plan to guide their trading. You must treat your trading like any other business.
- They all use position sizing. They have clear objectives written out, something that most traders/investors do not have. They also understand that position sizing is the key to meeting those objectives and have worked out a position sizing algorithm to meet those objectives.
- They all understand that performance is a function of personal psychology and spend a lot of time working on themselves. You must become an efficient rather than inefficient decision maker.
- They take total responsibility for the results they get. They don’t blame someone else or something else. They don’t justify their results. They don’t feel guilty or ashamed about their results. They simply assume that they created them and that they can create better results by eliminating mistakes.
- They understand that not following their system and business plan rules is a mistake.
A Few Notes From Adam Grimes
Adam Grimes (Chief Investment Officer of Waverly Advisors) prefaces his 2012 book, The Art and Science of Technical Analysis: Market Structure, Price Action, and Trading Strategies, by stating: “This book…offers a comprehensive approach to the problems of technically motivated, directional trading. …Trading is hard. Markets are extremely competitive. They are usually very close to efficient and most observed price movements are random. It is therefore exceedingly difficult to derive a method that makes superior risk-adjusted returns, and it is even more difficult to successfully apply such a method in actual practice. Last, it is essential to have a verifiable edge in the markets–otherwise no consistent profits are possible. This approach sets this work apart from the majority of trading books published, which suggest that simple patterns and proper psychology can lead a trader to impressive profits. Perhaps this is possible, but I have never seen it work in actual practice. …The self-directed trader will find many sections specifically addressed to the struggles he or she faces, and to the errors he or she is likely to make along the way. …[Institutional] traders will also find new perspectives on risk management, position sizing, and pattern analysis that may be able to inform their work in different areas.” Using example charts for many assets from different times over different time frames and from different markets, he concludes that:
From Chapter 1, “The Trader’s Edge” (Page 7): “Every edge we have, as technical traders, comes from an imbalance of buying and selling pressure. …we do not trade patterns in the market–we trade the underlying imbalances that create those patterns.”
From Chapter 2, “The Market Cycle and the Four Trades” (Page 45): “When buying pressure seems to be strongest, the end of the uptrend is often near. When the sellers seem to be decisively winning the battle, the stage is set for a reversal into an uptrend. This is why it is so important for traders to learn to stand apart from the crowd, and the only way to do this is to understand the actions and emotions of that market crowd.”
From Chapter 3, “On Trends” (Page 95): “…many outstanding trades come in trending environments. Market structure in trends is often driven by a strong imbalance of buying and selling pressure, it is often easy to define risk points for trades, and some of the cleanest, easiest trades come from trends. However, markets do not always trend.” (more…)
Weakest Part of Trading
The weakest part of any trading method is the trader themselves. There are many, many, robust trading systems and methods that do make money in the long term. The problem is the trader having the discipline and mental toughness to trade one of them consistently. The vast majority of time it is not a system failure but traders that fail in this game through one of seven common errors. If you can understand these error and overcome them you could make a lot of money in the right market conditions.
- The trader must have the discipline to take the system’s entries and exits.
- The trader must have the discipline to take the stop loss on a losing trade when it is hit and not keep holding and start hoping.
- No matter the method the trader has to manage risk through proper position sizing, getting greedy and trading too big will blow up even the best systems.
- It is the trader that must have the perseverance to stick to the method even during losing periods, and also stick with trading until success is reached.
- If a trader can not manage their mind then the stress will break them, I have seen this happen many times. If you can’t handle losing you can’t trade.
- The trader must find a robust method, must understand why it has an edge, and must believe in their methodology.
- The trader has to know themselves and trade the method that fits their risk tolerance levels and own psychology.
The good news is that if none of these error fit you when you lose money in a trade then the market was just not conducive to your methodology, and it is not your fault so don’t dwell on it.
Traders Should Accept these 4 Things
- Accept that the key to being a successful trader is having big wins and small losses, not big bets paying off. Big bets can lead quickly to you being out of the game after a string of losses.
- Accept that the best traders are also the best risk managers, even the best traders do not have crystal balls so they ALWAYS manage their capital at risk on EVERY trade.
- If you want to be a better trader then you need to accept that trading smaller and risking less is a key to your success. Risking 1% to 2% of your capital on any single trade is the first step to winning at trading. Use stops and position sizing to limit your losses and get out when your losses grow to these levels.
- You must accept that you will have 10 trading losses in a row a few times each year. The question is what your account will look like when they happen.
The art of War
Sun Tzu, the author of The Art of War, would make a great stock trader. Although The Art of War is a 2500 year old military treatise it could just as easily be written for today’s stock trader as the principles outlined therein are as applicable in the stock market as in the theatre of war. I read The Art of War again this past weekend and highlighted what I believe are some of the most pertinent and applicable principles for stock traders as seen through the eyes of Sun Tzu the would be stock trader. Make sure you copy and post these in a prominent place for quick reference when in the heat of battle.
I. 17 When the market is rewarding your trading strategy, you should modify your position sizing accordingly.
I. 26 Now the successful trader prepares before he enters battle. The unsuccessful trader makes but a few, if any, preparations before he enters battle. Proper preparation leads to victory; a little preparation leads to defeat; and no preparation leads to ultimate destruction! The one who is properly prepared is the one who is most likely to win.
II. 7 Appreciating the gains better helps you accept the losses.
II. 19 In trading, let your great object be a quick and decisive victory, not the slow death of a lengthy loss.
III. 18 If you know who the enemy is and you know yourself, you will never fear the next trade. If you know yourself but not the enemy, you will win one lose one. If you do not know the enemy or yourself, you will lose on each trade.
IV. 1 The good traders of old first put themselves beyond the possibility of defeat and then waited for the right time to defeat the enemy.
IV. 4 It is possible to know technical analysis without being able to properly apply it.
IV. 13 The successful trader wins his battles by making no mistakes. Making no mistakes establishes the certainty of victory.
V. 13 The quality of entry is like a well-timed swoop of a falcon which enables it to strike and destroy its victim.
V. 15 Proper preparation may be likened to the bending of a crossbow; decision, to the releasing of the trigger.
VI. 5 Take advantage of opportunities such as support and resistance where the enemy must put up a strong defense; take swift action and catch the enemy off guard.
VI. 19 Be prepared for battle by knowing the exact time and place for proper trade entry.
VI. 32 Just as water retains no constant shape, so in trading know the market is constantly changing.
VII. 5 Trading with familiar stocks is advantageous; with unfamiliar most dangerous.
VII. 13 We are not properly prepared to trade a stock until we are familiar with the most likely direction of the general market.
VII. 21 Ponder and deliberate before you enter a trade.
VII. 28 Now the trader’s spirit is keenest in the pre-market; by noon day it is becoming weary; and by post market ready to relax.
VII. 32 To refrain from entering a market that is prepared to defend its current course is the art of practicing patience by studying current market conditions.
VIII. 3 There are trades which must not be taken; sectors that are not ready to be attacked; patterns that are set up for failure; positions that are to be surrendered; egotistical commands that are not to be obeyed.
IX. 28 In a mixed market when some stocks are seen advancing and some retreating, it is a trap.
IX. 41 He who does not think through his trade while making light of the situation is sure to fall victim to a loss.
X. 24 The trader who makes money without coveting fame and loses money without fearing disgrace, whose only thought is to protect his equity and ignore his ego, is considered to be a jewel of the kingdom.
XI. 17 When it is to the trader’s advantage, he will enter a trade; when otherwise he will not.
XI. 67 Trade in the path defined by rules and do not face the enemy until you feel you can trade with confidence.
XII. 15 Unhappy is the fate of the trader who tries to win his battles and succeed in his decisions without cultivating the spirit of confidence, for the result will be a waste of time and a drain on his trading account.
XII. 17 Do not trade unless you see there is an advantage in doing so; use not your money unless there is something to be gained.
XII. 22 The successful trader is heedful and full of caution. This is the way to have peace of mind and to live to trade another day.
XIII. 4 What enables the wise and successful traders to trade and conquer, and achieve things beyond the reach of ordinary traders, is proper preparation.
Practical Aspects of Trading…
Successful traders examine the current market conditions to determine if they are bullish, bearish, or a trading range environment. After determining the current market environment traders can select the tools from the their trading tool box that perform best in the current conditions. When the market conditions change then traders need to adapt to the new market environment by selecting new tools that are most appropriate for the new market conditions.
In addition to adapting to the current market conditions by using the appropriate tools from the trading tool box there are several practical aspects of trading that traders need to master.
Never enter a position without having a plan for exiting the position. If you Do not know where to get out of a position you should not enter it in the first place. In swing trading time frames stocks often run to the next resistance or Support level and then stall. We have seen that stocks rarely remain outside the Bollinger bands for long, so when a position reaches the Bands it is often a good Place to look at profit taking, especially in trading range environments.
There is usually no need to rush in when the markets trend changes. Any trend worthTrading does not require you to be in on the first day, by definition. It is usually better to make sure the trend change is real and then react rather than assuming that the first Day of a potential change is something that is going to continue.
There are a lot of jobs where people get paid every Friday. Trading is not one of them. There will be profitable weeks and losing weeks as the normal statistics work out. Remember that if you make enough trades there is a reasonable probability of seeing…
ten losing trades at some point, even with good trading systems. This is part of trading and traders need to allow for it when they work out position sizing and money management techniques.
You do not have to trade every day or take trades just because they came upon the evening scan. Carefully consider the recent price and volume action in the market before taking positions. Look for the best trades, consider long trades that have not shown a lot of recent distribution and have ‘room to run’ before hitting the next resistance area or the upper Bollinger Band.
Make sure that your position sizing is such that if all your current positions were stopped out that the total loss is something that is still comfortable. This happens from time to time and wishing it did not will not change it. Be prepared by using sensible position sizes.
Review each of your positions every evening and determine if it is something you still want to be holding based on the recent market action and the price volume patterns of the position. Longs going up on declining volume are showing weakness and I generally close out those positions and put the money to work in something stronger. You are hiring a stock to do a job for you, if it is not doing the job fire it and hire another. (more…)
The “secret” ingredients
To be successful in the markets you need to know:
– what to buy (equity selection);
– When to buy it and when to pass on it (risk management);
– When to exit (time management).
The most essential part of equity selection is finding/creating a trading system with positive expectancy. Look for the catalyst/catalysts than has/have the potential to start a big move in the desired direction. There are two catalysts I focus on – earnings related and sector related. I pay attention to price, because it measures the only factor than really moves markets – confidence. It always says more than any other source of information. Reaction to news is more important to news itself.
Risk management has two basic elements: defining risk/reward ratio for every position I consider to get involved in and position sizing (how much to buy, what % of capital to put on risk).
Time management involves taking into account the opportunity cost. How long to stay in a position?