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Putting the Math in Your Favor

 Ahhh the sweet smell of success. Today I finished the session with a P&L of $380, my best performance in weeks. Lately, my trading has been characterized by excessive losses, heartbreaking whipsaws, and general lack of discipline. I made a promise to myself to change my wily ways and get back on the path to righteousness. In order to do so, I first had to identify the factors that were contributing to my demise. Looking back over my scorecards, I noticed a disturbing pattern; my losses had become humongous while my gains remained minuscule. I bore the scarlet letter; the whole town knew I was nothing but a dirty, no-good amateur. From a psychological perspective, it is easy to understand why this hallmark plagues so many traders. When a position moves in an unfavorable direction, many traders tend to add into the trade believing a reversal looms on the horizon. When the ever expanding position continues to trend, the pain eventually becomes too great to bear and the trader pukes. Conversely, when a trader begins to make money on a position, the natural inclination is to book profits for fear that the stock will reverse its course. This mindset creates a portfolio full of robust losing positions and meager winners.

Recognizing the perils of this traders’ paradox I sought shelter from its relentless clutches. I recalled a guiding principle I learned in my very first week at Hedge Fund Live; putting the math in your favor is the only assured way to consistently make money. In order to accomplish these ends, one must constantly control his or her reward to risk ratio by only risking a fraction of what one is willing to make on any particular trade. The most effective way to control one’s risk to reward ratio is to control one’s share sizing. If I noticed a losing position was larger than other winning positions, I immediately took down risk. Furthermore, I allowed my winning trades to run in my favor for longer than I normally would. Using this strategy I was able to finish the day with a pad of 6 winners and 1 loser with my largest winner coming in at $140 and my only loser costing me ($2).



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.