Episode 268: Philosophical Musings About Trade Size and Expectancy

by robbooker on July 2, 2014

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Welcome to The Traders Podcast, Episode 268. The photo above is your host Rob Booker with Bradley Fried and all their trader friends in Tokyo, Japan. In this episode, Rob talks about a question he recently got from a reader of his blog at Experts.ForexMagnates.com regarding trade size. The question was: What is the ideal trade size for a beginning forex trader? This question leads Rob on a philosophical journey about trade size and expectancy, among other things. Thanks for listening to The Traders Podcast.

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{ 3 comments… read them below or add one }

Brian F. July 2, 2014 at 2:16 pm

What is the ideal trade size for a beginning forex trader?

That’s a question for whole books, but the bottom line is position sizing needs to be dynamic. Here are a few reasons why:
First, small amounts of money matter because of compounding. Humans experience what reality we let into our heads one instance at a time, and we are completely blind to large numbers. Therefore, unless you sit down with a spreadsheet and run the numbers like Brad in Episode 146, your human mind will always regard the proper amount of sizing to make you rich over time as too small, and the perfect size to make you poor as also too small. Maybe if we had 1000 babies at a time like an octopus we’d be able to think in terms of probability, but there it is, most people doom themselves right from the git-to by trading too big.
Beyond that, I see five factors regulating our position size: account size; outliers; liquidity; volatility; and psychology.
1) Your account size places maximum safe probability limits on your regular position sizing. (This is the beginning trader graveyard).
2) But, trading is about surviving AND capturing outliers. So you whip out your recovery chart, and your journal, and figure how much you can afford to lose chasing outliers. For example, my chart tells me if I lose 15% of my account (extreme example), I’ll need 17.6% return to get back to zero. My journal tells me it usually takes me 8 weeks to make that much money. If I’m ok spending two months repairing my account, then I can chase that once a year outlier with a whopping 15% position. But, keep in mind you won’t be available to chase another outlier during the recovery period, and you will be vulnerable to a drawdown during this period. Stalk a smaller prey, live to hunt another day. (The more advanced losers don’t plan ahead for outliers).
3) Liquidity is another factor. It’s not true you have to trade large liquid stocks. Illiquidity on the losing side is what makes price move. However, the only way to escape the losing side on illiquid issues is to trade smaller so you can get a fill. (This is the graveyard for accomplished traders who understand defense but can’t generate consistent offense).
4) Volatility requires us to widen our stops or be stopped out. This increases risk. The chief way of dealing with that risk is to size down so you are not so dependent upon stops. Position sizing is the chief way to control risk, not stops, particularly if you hold overnight or trade volatile issues. (It’s not true this is a 50/50 game, sometimes the bulls win, sometimes the bears win, and sometimes the volatility wins and everybody else loses.)
5) Psychology: Your account size places maximum safe mathematical limits on your regular position size, but your mind sets the appropriate personal limits within those boundaries. If $1000 is a lot of money to you, your judgment is going to be impaired beyond those limits. (This kills everybody until they finally give up trying to have discipline trading the wrong way. Then they run the numbers in a spreadsheet and trade like Brad.)

As you can see, there’s a lot of issues involved in properly sizing our positions, and I didn’t even touch on other important topics like pyramiding, handling losers that get away from us, drawdown rules, draw up rules (Yes Virginia, there are such things as draw up rules), and scaling in or scaling out. Trading is about making more money when you are right than when you are wrong, or more specifically, because being right or wrong is irrelevant, closing losers and holding winners. Rob said new traders tend to let losers run, but old traders tend to close winners too early. Fortunately, the medicine is the same. If you are a new trader or an old trader, size your position until you can close your losers and hold your winners.

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tim martin July 3, 2014 at 12:51 pm

Tim martin
hi everyone i like to say i agree 100% with what Brian says expect for one little thing
using a stop loss or closing bad trades; i never use a stop loss or close a bad trades down in the three year i been trading; i keep my bad trades open until i am in profit then i close the hole thing down this year i have taken around 500 trades and bag over 9000 pips so far i am not saying you got to do it this way i am just saying because there is a lot out there saying you got to use a stop loss you got close you losing trades down i say no you don’t have to
there are many ways you can skin a cat in the Forex market

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Brian F. July 3, 2014 at 8:34 pm

Thanks. Actually, that was the point and that’s why position sizing is my favorite topic. If you understand position sizing, you can trade anything, high volatility, low liquidity, no stops, penny stocks, wherever you see opportunity. The world is your cat to skin (yuck).

The funny thing about this stuff is the little things get more interesting and more robust as you rack up experience and the things that were really interesting when we started out, like indicators and indicator values, get pretty boring.

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