Category Archives: Position-Sizing

Moments Before the Plunge

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A very common sight right through school and college was last minute cramming. It was an epidemic. I was more the odd one out, walking around without any books a day before any exam. Reason was, I was convinced that if I was unsure of myself a day before an exam, delving into course-material at that stage would make me feel even more insecure.

“Do you have any coffee?”, whispered someone. This fellow woke me up in the middle of the night, leaving with my entire bottle of instant coffee-powder. He was doing an all-nighter before some board exam. At the cost of not being super-prepared, I preffered to sleep the night.

Interestingly enough, I’ve had the chance to speak to some brides and grooms hours before the knot was tied. Jitters, man. Everyone was jittery, well almost. The most common feeling was “… what if this is the wrong step?” This was followed by “…what if we don’t get along?”

Seriously, people, why moments before the plunge? Why does the human being expose him- or herself to destabilizing thoughts just before pulling the trigger? There’s ample time much, much before, to sort all the destabilizing stuff out while deciding whether one goes ahead with a particular action. Similarly, there’s ample time to study for an exam if one starts from day one. Just an hour a day, throughout the term, and there’s no need for any all-nighters.

If you’re all sorted out and well rested to boot, you then have the best chance of seeing peak-performance emanating from your system.

And that’s what we are looking to be, just before opening a market position.

We’ve sorted out our worries and fears. We know how much risk we can handle, and have systems in place to manage this risk, i.e. we know what we have to do if our trade goes bad. Also, we know how to behave when a trade does well. We are aware about the size of the position we need to put on as an appropriate ratio to our stack-size. We’ve tuned in to the idea of position-sizing, and are practising it as we win more or lose more. Basically, we have our basics in order.

After that, we have to see whether we actually feel like trading. Even when our trading system identifies a set-up, the innate go-ahead to trade might just not come from within. There can be some reason for this. For example, there could be some tension prevailing at home. Sort out the external disturbance to the level of closure if you can, or it might constantly disturb trading.

So, internal sorting out, external sorting out, then comes a trade set-up, and one takes the trade. No jitters, here, there, anywhere. All jitter-causing avenues have been chewed up and digested. That’s when triggers can be pulled when they appear.

When Mrs. Market asks you to ride alongside her, your bag should be packed already. You can then jump on to her motor-bike without worries, for you’ve packed well for the trip.

Moving on to a Higher Table

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You’ve started to rake in regular profits on your poker table, or, if you will, on your regular trade-size.

Common-sense now tells you, that you need to scale it up a bit. After all, you’d still be risking the same percentage of your stack-size per trade. Simultaneously, if your win-ratio remains constant, you’d be allowing your stack to grow at a faster pace.

You move on to a higher table.

Welcome to the concept of position-sizing.

Those who position-size can evolve into huge winners in minimum time. Even though the idea of position-sizing is so central to trading, it is still one of the most under-discussed of topics. We need to thank Dr. Van Tharp for teaching this concept properly.

Think about it. When you win, your principal increases. On the next trade, you then put the same principal percentage at risk like you’ve always done. Because your new principal was more, it allowed you to buy more. Thus, you put yourself on the line to win more.

What’s essential here is also to down-size your position when you are losing. Taken a few bad beats in a row? Move down to a lower table for a bit, man. Allow your stack to recuperate at this lower level and then some before moving back higher. With that, when you’re losing, you start to risk less. Crucial point.

Of the different methods available to you to position-size, here, we speak about increasing trade-size when a new trade starts.

The advantage you enjoy when you’re doing pure equity is that on each new trade, your position-size can pinpointedly be adjusted according to your stack-size. Scale-up, scale down, trade upon trade, as the situation demands. Beautiful.

Why does this work out so beautifully for you?

You see, your system gives you an edge. You are opening your positions on high-percentage winners only. Period. Simultaneously, you are cutting your losses at your pre-defined maximum. You are also allowing your winners to win more. And, you are taking your stops. Even if your system then gives you a 55:45 edge over Mrs. Market, you’re doing great. Over a large sample-size (many, many trades, or for that matter many, many poker hands), your stack will increase with a high level of probability. As it goes on increasing, you keep turning on the heat by increasing your position-size further and further.

What happens then? What do you see?

Something beautiful happens.

Your trading principal (what we’ve been calling stack-size all the time) starts to increase exponentially. Have you seen the progress of an exponential function as one travels from zero to the right on the x-axis (the x-axis here would stand for sample-size or the number of trades taken)? If not, check it out on the net.

A good system should give you a 60:40 market-edge. In the Zone, you’d probably trade at 70:30 or beyond. That’s 70 winning trades out of every 100 taken, and 30 losing ones. Imagine what that does to your trading principal over 1000 trades, if you adhere to position-sizing, let your winners ride and take your stop-losses.

The numbers will boggle your mind.

Go for it.

The Sweetest Spot

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In the markets, we often lose our balance.

Then we find it. Only to lose it again.

The key is maintaining this balance over long periods of time.

There’s a spot, where everything, suddenly, goes into balance. I like to call it the sweetest spot. What are its characteristics?

Firstly, at the sweetest spot, health is intact, on the physical as well as on the mental level. Then, one has identified a trade, entered it, and the trade is in the money. At this spot, the spouse respects you and your profession, because neither you nor your profession are bothering him or her for space. Relationship with him or her is harmonious. At the sweetest spot, you find time for your children. You’ve got a rapport going. Your off-spring learns from your every word and action.

Phew, sounds amazing!

Wait, there’s more!

At the sweetest spot, one is debt-free. Neither is one under-trading, nor is one over-trading. Reactions to market events are sharp, and one turns with the market, i.e. one is in the Zone. As profit levels increase, so does position-size, proportionately. You are getting your strategy basics right, one after the other.

At the sweetest spot, goodness wells inside the human being, and he or she does an extra bit for the benefit of society.

Life, profession, existence…it’s all one smooth, harmonious, automatic flow.

Then, in a flash, the spot is gone. One or more of the many factors mentioned tend to go haywire. That’s quite normal.

Which only means, that you start looking for the sweetest spot again.

Whenever you find it once more, your primary goal is to maintain it as long as possible, again, and again and again (to the power of n, with n > 1).

Before you realize it, you are then staring at financial freedom. You are there, financially independent of any other factor or being. You have arrived.

Some things in life are really sweet, and worth striving for.

Taking Compulsion Out of One’s Trading Equation

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Mr. Cool’s next trading cameo starts a few months after his last blow-up. He keeps coming back, you’ve gotta give him that.

This time around, his girl-friend wants a fur coat. Cool is determined to buy a fur coat for her from his trading profits.

Thus, Mr. Cool has put himself in a position where he is compelled to trade. Compulsion adds pressure. A trader under pressure commits basic blunders. There’s no question of getting into the Zone while pressure mounts.

Sure enough, Cool overtrades. Apart from that, he fails to cut his position-size after the first run of losses. These are two basic mistakes. They are being caused by compulsion. Mrs. Market is ruthless with players who commit basic blunders. As usual, Cool blows up, yet again. The fur coat is not happening. In fact, there’s no girl-friend anymore.

Meanwhile, Mr. System Addict has been evolving. He’s achieved a large-sized fixed income by ploughing previous profits into safe fixed-income products. He’s under no compulsion to trade. His fixed income allows him to live well, even without trading. He has a lot of time to think. Often, he gets into the Zone, where he’s moving in tandem with the market, and is able to swing with the market’s turn. What makes him get into the Zone so often?

It’s the lack of pressure. He’s comfortable. A free mind performs uniquely. There’s no question of making basic mistakes, because full focus is there. Addict is a human being who is aware. He knows when he is in the Zone. That’s when he doubles up his position-size and logs his trade. His win : loss ratio is 70:30 by now. His trading income surpasses his fixed income for the year.

Putting it all Together – The View from the Mountain-Top

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Remember getting into the driver’s seat for the first time?

It all seemed so difficult. You got the brake-clutch-accelerator coordination all wrong. Proper gear changes were a far cry. There was no question of looking into the rear-view or the side-view mirrors, since you were looking straight. And the shoulder-glance – just forget about it, you said to the instructor.

Slowly, it all came together, perhaps after a 1,50,000 km behind the wheel. Now, driving is a piece of cake. It’s all there in your reflexes. It’s as if the car is connected to your brain, and is an extension of your limbs.

It took time and effort, didn’t it? And why would it be any different in the markets?

Flash-back to 1988 – high school – our Chemistry teacher Frau Boetticher used to teach us to strive for the “Ueberblick”. Roughly and applicably translated, this analogical German word means “the view from the mountain-top”. In Street lingo, the Ueberblick is about life in the Zone. Frau Boetticher used to push us to get into the Zone. She knew that then, our reflexes would take over. She passed away before our A-levels, after a very fulfilling and successful lifetime of teaching. She was the best teacher to ever have taught me.

When your reflexes make you enter a market, or exit it, or decide on the level of a stop, or a target etc. etc., you’ve managed to put it all together. Doesn’t happen overnight, though. The ball-park figure of 1,50,000 km behind the wheel changes to roughly 7 years of market experience, before one can expect to put it all together on the Street.

Where does that leave you?

As a thumb rule, money-levels at stake in the first 7 years on the Street need to be low. When you’re getting the hang of things, you just don’t bet the farm. That’s common sense, a rare commodity, so I’m underlining it for you.

On the Street, you only learn from mistakes. They are your teachers, and they prepare you to deal with Mrs. Market. No books, or professors or college will make you fit enough to tackle Mrs. Market, only mistakes will. Make mistakes in your first seven years on the Street – make big mistakes. Learn from them. Don’t make them again. Get the big blunders out of the way while the stakes are small. Round up your learning before the stakes get big.

Once your reflexes all come together, you can start risking larger sums of money, not before. Also, in today’s neon age, it’s difficult to stay in the Zone for prolonged periods of time. Something or the other manages to distract us out of the Zone, whether it is internal health or external affairs. When you feel you’re out of the Zone, just cut back your position-size. When you feel you’re back in, you can scale up your position-size again.

It’s as simple as that. Useful ideas have one characteristic in common – they are simple.

Blowing up Big

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Derivatives are to be traded with stops. Period.

Stops allow you to get out when the loss is small.

Common sense?

Apparently not.

Who has common sense these days?

Also, the human being has embraced leverage as if it were like taking the daily shower. Bankers and high-profile brokers have free flowing and uncontrolled access to humongous amounts of leverage.

Apart from that, the human being is greedy. There’s nothing as tempting as making quick and big bucks.

Combine humongous amounts of leverage with large amounts of greed and brew this mix together with lack of common sense. That’s the recipe for blowing up big.

Every now and then, a banker or a high-profile broker blows up big, and in the process, at times, brings down the brokerage or the bank in question. In the current case at hand, UBS won’t be going bust, but its credibility has taken a sizable hit.

Bankers are to finance what doctors are to medicine. Where doctors manage physical and perhaps mental health, bankers are supposed to manage financial health. Bankers are taught how to manage risk. Something’s going wrong. Either the teaching is faulty, or the world’s banking systems are faulty. I think both are faulty. There exists a huge lack of awareness about the definition of risk, let alone its management.

Trained professionals lose respect when one of them blows up big. Such an event brings dark disrepute to the whole industry. Most or all of the good work to restore faith in the banking industry thus gets nullified to zilch.

A doctor or an engineer is expected to adhere to basics. I mean, the basics must be guaranteed before one allows a surgeon to perform surgery upon oneself. A surgeon must wash hands, and not leave surgical instruments in the body before stitching up. Similarly, an construction engineer must guarantee the water-tightness or perfection of a foundation before proceeding further with the project.

Similarly, a banker who trades is expected to apply stops. He or she is expected to manage risk by the implementation of position-sizing and by controlling levels of leverage and greed. Responsibility towards society must reflect in his or her actions. A banker needs to realize that he or she is a role model.

All this doesn’t seem to be happening, because every few years, someone from the financial industry blows up big, causing havoc and collateral damage.

Where does that leave you?

I believe that should make your position very clear. You need to manage your assets ON YOUR OWN. Getting a banker into the picture to manage them for you exposes your assets to additional and unnecessary stress cum risk.

In today’s day and age, the face of the financial industry has changed. If you want to manage your own assets, nothing can stop you. There exist wide-spread systems to manage your assets, right from your laptop. All you need to do is plunge in and put in about one hour a day to study this area. Then, with time, you can create your own management network, fully on your laptop.

Your assets are yours. You are extra careful with them. You minimize their risk. That’s an automatic given. Not the case when a third party manages them for you. Commissions and kick-backs blind the third party. Your interests become secondary. Second- or third-rate investments are proposed and implemented, because of your lack of interest, or lack of time, or both.

Do you really want all that? No, right?

So come one, take the plunge. Manage your stuff on your own. I’m sure you’ll enjoy it, and it will definitely teach you a lot, simultaneously building up confidence inside of you. Go ahead, you can do it.

Baby-Stepping One’s Way Up the Financial Ladder

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Everyday, without fail, I get a few opportunities to make this a slightly better world. I’m sure you do too.

And I’m ok with that. No further ambitions. Just doing what comes my way. I’ve always done what I believe in. Have never followed crowds. Have never joint someone’s battle which I don’t fully understand.

Baby-step contributions are drops in the ocean. Nevertheless, they are contributions. I’m proud of the fact that opportunities to contribute come my way regularly. I don’t act upon all of them. Have become very discerning of late. Don’t want to be involved with any frauds whatsoever. And India is brimming with frauds. For me, the world of contributing is about baby-steps. I’m content with that.

I believe that baby-stepping is the way up the financial ladder too, as far as one’s investing or trading activity is concerned.

In the world of trading, there exists the concept of position-size (developed to the nth level by Dr. Van K. Tharp). In a nutshell, this concept teaches one to scale it up one baby-step at a time as one’s account shows a profit. Also, one learns to scale it down a notch upon showing a loss.

Common-sense? Then why isn’t everyone doing it?

Why does everyone around me behave as if he or she is gunning for the big hit? The bringing down of institutions. Of governments. The desire to make it big and in the limelight in one shot. The desire to bring about sweeping change within a week’s time. Ever heard of speed of digestion and incorporation? Metabolism? Assimilation? Speed of evolution?

Life takes time to happen. Let’s give it that time. Let’s not hurry it up with our over-ambition. Do we want life to blow up on our faces because of over-ambition?

Frankly, I want to evolve with equilibrium. Really, really not in one shot. My system will explode if it tries to evolve in one shot. Many people are going to find that out the hard way on their own systems.

And I’m really satisfied with baby-stepping it up the financial ladder, using the concept of position-sizing. Slow and easy, little by little, tangible progress, day by day. No nuclear blasts, no tense situations or mood-swings, lots of time for the family, small quantums of realistic progress and its assimilation… what more can one ask for?

You should try it too.