Dynamic vs. Static Position Sizing part #1
I was taught at a very early age by my father that "having the money to purchase something and being able to afford it are two completely different things". I had no idea that a lesson in my childhood would be so applicable in the world of trading. Allow me to illustrate. Within a hypothetical trading account let's assume I have $25,000 to trade. Let's also assume that I wish to trade the SP500 E-mini contract and that my online brokerage sets the minimum margin requirement at $6,000 per contract to initiate a trade. Simple mathematics tells us that we can afford to trade four (4) contracts the next time we decide to take a trade on the SP500 Emini contract. However, what if I had a 5 point stop loss in place? Again going back to the SP500 Emini example, I know that each point represents $50 and a 5 point stop totals $250 PER CONTRACT. By trading the allowed 4 contracts, I would have to accept that sustaining a -$1,000 loss is a reality in the event of a losing trade. A -$1,000 loss isn't a problem - if you're trading $70,000 or more but to sustain a -4% loss of your trading capital on a single trade because you are trading a smaller $25,000 account, is just poor risk/money management -
"having the money to purchase something and being able to afford it are completely different things".
Just because you can "pay" to trade 4 contracts with a $25,000 trading account does NOT mean you can afford to. Of course someone can challenge this argument by adjusting the stop loss to say a -2.50 point stop loss. Well, let's consider that. Yes, we have now reduced our percentage loss to -2% but we have also just opened up a whole new can of worms. When a trader tightens his or her stop to minimize losses, they are subjecting themselves to being whipsawed in and out of the market which adds additional losses due to slippage and commissions. By simply reducing your initial number of contracts traded (despite your ability to trade more) is the foundational thinking that separates the serious and consistent trader from the erratic "wannabe". The best traders, the ones who make a very nice living at it, have no crystal ball - they take losses like the rest of us.
When a loss happens they accept that as part of trading and move on and their losses are on their terms, within their acceptable risk parameters. This by no way is to suggest that they stay at that beginning fixed number of contracts as their account value grows. Additional contracts can and ARE added but only as long as it falls within the above mentioned pre-determined risk tolerance to their trading equity. "Live to trade another day" is a well known saying in the trading community. In the 2nd part of Dynamic vs. Static Position Sizing, I will introduce you to a tool within the m3- Money Management Modeler which will show you how to progressively add or reduce the number of contracts (or shares for stock traders)you trade as your account rises or falls based on recent trading activity. For now I have attached a short 5 minute web-tutorial featuring the m3 tool which shows you the type of risk management features built into this platform which address risk management, position sizing and probability on a leg by leg basis unlike any other trading tool available today.
click the link below and enjoy part 1 of the video series
Fulcrum Shift Trading