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Friday, December 6, 2013

Why Small Position Sizes Are Ideal


Why do I recommend small lot sizes?



There are happy traders who say these things:

“The markets aren’t hunting for me. I’m part of a large trading community. I know that losses are normal part of doing any business. My winnings are on the way.”

“I know that the volatility in the markets is normal. It’s what has brought me gains.”

“Trading has become my calling! I trade with peace of mind because my losses are small and easily recoverable.”

I’m totally satisfied with whatever the markets give me – whether more or less. I just need to focus on risk control. Profits will take care of themselves.

Sadly, there are also suicide traders who say these:

“That’s me, always perspiring profusely in this severe winter, and that’s whenever there’s a small movement against me.”

“Why does the market always move against me? Who’s my enemy out there? Contend, O Lord, with those who contend with me; fight against those who fight against me.”

“The fluctuations of the markets are fluctuating my heart!”

“Can you see? Another loss. That’s enough. I can’t continue like this. I can’t take it anymore.”

If I use 0.01 lots per trade on a small account and make 500 pips in one month, my profits would be about $50 (whereas it would be $500 if I use 0.1 lots). Someone who uses 1.0 lot per trade would’ve made approximately $5000 from a gain of 500 pips. 10.0 lots would’ve then brought approximately $50,000 as a profit. I’m not saying that I can’t use big lot sizes, but it’ll be on sizable accounts, not relatively smaller accounts. Recently, someone in Russia made 3500% profit in less than one week! Isn’t that attractive? Isn’t it a most welcome opportunity if you can increase your account 35 times in a week? We can see that higher risk enables us to make more money, but the demerit is that it can also bring huge losses when a trading strategy enters a protracted losing streak. Only small sizes can make one survive that kind of protracted losing streak.

For many years, I’ve always advocated the use of very small lot sizes when trading.  This is mandatory for keeping one’s portfolios safe permanently. Nevertheless, I’ve been derided for using minuscule sizes. Those who recommend big lot sizes won’t ever tell you how many accounts they’ve blown. They may have more experience than me and have better strategies than I’ve. Yet, when it comes to risk management, I believe I’ve improved a lot. There were great traders in the past who’re no longer trading. Why? They often betted too big in the markets that couldn’t be predicted with absolute assurance. If you can’t sleep because of open trades, if you can’t leave your PC screen or you’re crying or extremely anxious, then what you’ve risked is too high.

When negativity is considered against positivity, it’s common for people to double or treble their risk after taking a loss, so as to recover quickly. Many traders feel that the bigger their position sizes, the bigger their profits. This mindset is wrong. The factors that can help grow your portfolios over time are conservative risk control, discipline and small lot sizes. Certain people feel that smaller position sizes are tantamount to smaller stakes, which reduce their income. Do you also want to use the RSI to build your new estate? There’s an illusion of having huge gains when fat lot sizes are opened, though the real uncertainty comes from the inability to ride your positions for as long as possible, even with clear negativity. In addition, we go against the norm when we think the only way to control risk is to cut our profits quickly. Still, an effective speculative strategy can receive a margin call if position sizes are too large.

Stop losses also must be physical and rigid. We surmise that there are new trading setups which come up every day – always. There are always new opportunities in the markets. As it always will be with small sizes, trades that hit stops would merely bring small and therefore, bearable losses; and this is the usual way to push a portfolio from the recent drawdown to the eventual increase. It’s the anticipated increase that overrides the recent drawdown.  My personal positions sizing ideas aren’t the most commonly accepted, yet I’ve always remained triumphant, no matter what the market does. The ideas that make you triumphant irrespective of what the markets do are great ideas.

We’re no robots which got no emotions, yet we tend to master irrational emotions as we gain more experience in the markets. When you risk too much, you’ll attach excessive importance to every open position no matter what – so you need to change this attitude. The art of speculation should be approached with some form of rationality; it’s not your whole world, for there are other things in life those matters a lot, so every open position is not your life. When you keep your lot sizes very small, and they don’t eat your account with small unfavorable fluctuations, you’re fine. When those lot sizes are very small and perpetual and loss trades don’t make you cry, that’s when you’ll be able to control your emotions. Approach everything with rationality, treat each trade with a degree of sanity, and cut how much you risk drastically if you’re going gaga. Once again, cut how much you risk drastically and be responsible for that. Put a limit on how much you risk per trade, put  limit on how much your risk per day or per week or per month. When you do this, then you know your maximum loss in a given period, and you’ll be satisfied with whatever the markets do to you. Yes, you’ll be OK.

Great traders know that those who often bet big are suicide traders. This article is concluded with the insightful quote below:

“Do not risk more than 0.5 to one per cent of your capital per trade at the beginning. Less is often more. If you are used to the strategy and you have traded it over a longer
period of time you can vary the risk and maybe even increase it. But you have to take the drawdowns of the strategy into account which increase with the higher risk. Be aware of your total risk: It is the sum of the open risk of all active positions. Your total risk
should not be greater than 2.5 to five per cent – then your capital will not decrease too much if you have several losing trades.” – Julian Komar (Source: www.tradersonline-mag.com)

Azeez Mustapha

Market Analyst, Trading Signals Provider and Coach

Eye-opening trading lessons: Lessons from Expert Traders



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