Some traders are able to turn small amounts of money into very large amounts.
It might be tempting to believe that this is because of risky trading practices and sometimes it can be. If you take large positions compared to your account size you could get lucky. If you are willing to take big risks, you can earn big rewards.
Of course, while this may work for a while, it’s not a recipe for long-term success. As Market Wizard Ed Seykota says, success in trading is about longevity, and taking big risks in your trading account is not the way to stay in the game for the long run.
Guest post by Sam Eder of www.fxrenew.com
The thing that separates the top traders from the traders that do not make it, is they learn to temper their risk taking with risk management. They have developed processes for risk taking that protects their capital, while really letting them profit when things are going well.
You can be far more aggressive when you are making profits
To make large profits, you can increase your bet sizes after periods of high profitability. This allows you to take large position sizes whilst avoiding risk to your core capital.
This is the “market’s money” concept. Market’s money is where you risk your profits, either on a trade or on your account, to trade at a larger size.
To do this, once you’re comfortably in profit, you simply risk increase your position size on a high confidence trade. This process means that you can only get hit when you are being paid, but not from a standing start, and you give yourself the best chance to be successful when you are risking more.
If you get too careful about risking your gains, you’re not going to be able to extract a large profit.
When you are feeling more attuned, gradually increase your position size
When you are doing things correctly, you can expand your involvement in the market.
This is a very common mentality amongst the top currency traders, along with the flipside of trading smaller when things are not going well. If you are picking it well, and the market is going in your favour, be prepared to gradually increase your trade size.
This will mean that you make the most out of the good times when you are most attuned.
It takes courage to be a pig
Stanley Druckenmiller, the heir apparent to George Soros’s Quantum Fund, colourfully suggests that for truly superior returns you need to have the “courage to be a pig”. In one of his particularly insightful interviews, he says that the way to make truly superior profits is to grind it out until you are up 30-40% and then (if you have the conviction) go for a 100% year.
You work hard with well-contained risk, until you have achieved a moderate return. Then really go for it and increase the position size on your best ideas. Again, this method allows you to keep your risk to your core capital small, while still having the potential for very large returns.
Increasing your position size on a winning streak can lead to large loss
This is the downside to increasing your position size when you have profits. If you are on a winning streak, and you increase your position size, you are guaranteed to have your biggest loss.
Other good traders, particularly those involved in system trading, preferred to keep their risk small and constant. This is the exception that proves the rule. It depends on the personality or the trader, or the requirements of the system.
What do you think?
How does your position-sizing strategy change “” either when your account has locked in profits, or when a trade is going for you?
Or, do you prefer to keep your risk the same on every trade?
Sam Eder is co-owner of FX Renew, a provider of premium Forex signals from ex-bank and hedge fund traders