The Importance of Position Sizing for Trend Trading

In a couple of my earlier articles as well as my interview with David Penn (Read Part 1 and Part 2 of the interview here), I expressed disdain for day trading. Strange view by a former pit trader who only day traded for many years.

Of course floor guys had advantages that you don’t. I believe most of you would be increasingly successful by trading smaller and for bigger multi-day swings. The pursuit though of swing profits shouldn’t mean that you need to sit with swing losses. In these markets you need to develop such flexibility that a long term position will be exited immediately if your technical or fundamental view is invalidated. By imposing a few rules to your discretionary trading you’ll hopefully not be hung out to dry during those frequent periods when your big picture scenario is out of sync.

Assume You’re Going to be Wrong and Position Size Accordingly

Why would you assume otherwise? Oh, because you’re smarter. Here’s a clue. Everyone who’s trading big enough to move these markets is smart. Genius smart. Winning traders are either wise guy smart from the street or quaint smart from MIT but a fool and his trading capital are soon parted. Your higher intelligence is merely a required prerequisite to stay a few extra hands at the table but it’s no edge by itself. Here’s a good example for you football fans of zero sum genius. Let’s say we clone Bill Belichick so that he’s coaching every team in the NFL. Those 32 Belichick’s at the end of the season would have a combined record of exactly .500.

So assuming your best guess might not be even as good as a random-trade position that won’t annihilate you when you’re wrong. Nor if you’re wrong again. And again. If you need room then take it. But keep your size down correspondingly. Not to mention if you’re as smart as you think you are, then why feel the need to kill it on each trade? Your innateness should give you insight advantage over a wide sample of trades. Hubris is a tool. Use it.

Plan Your Trades

Novel stuff, huh? Do I wake up some mornings insanely clicking the mouse like a postal carrier with a gun? More often then I’d like to admit. Let’s face it — many of us here are attracted to trading because we’re action junkies. In Zen fashion let’s embrace that reality and try to make it work to our advantage. Discretionary trading is a series of shouldas. I shoulda got out, I shoulda stayed, and I shoulda moved my stop higher. Like a good coach who has plays designed for every situation — know ahead of time what your reaction will be to a market that opens hard in your favor or hard against you. Years ago when I was working with Bernie Kane who later became the  Director of Proprietary Trading at the Gelber Group, I was amazed how each morning his notebook included a course of action for over a half dozen different opening scenarios. Bernie prepared hours each night to be tested and ready. Unlike football there’s no “timeout” traders can call to search for a play when the market is in the midst of a 5% move off the open. Assume the unexpected and have a trading playbook at the ready for a multitude of events.

Don’t Blame the Market. It’s Just Doing as It’s Told

The market doesn’t know where it’s going either so don’t feel confused. I hear too many traders speak of “the Market” as if it’s some sort of omnipresent God who if you had his ear would whisper, “just between you and me I’m planning to print 5716 on May 8th”. The market is nothing more than a bunch of guys like you, me and some MBA who’re making decisions on what we perceive at this moment to be truths. The basis of those truths can change as quickly as a nuke erupting or Dr. No hacking as a rogue into a GLOBEX terminal. Accept the market’s future as one giant unknown. You’re not a bystander in events but rather an active principal. You may have an idea that the Steelers will win the game but you have little idea how it’ll happen. Will they return an interception for a touchdown or click off a couple of bombs? There’s an infinite number of ways the Yen can zig and zag 200 pips. All you can do is assign probabilities but any notion that you or anyone else know is simply fallacious. You often know as much as Soros. For real.

Clearly the market doesn’t know or care about your position but if you’re long on a trend day down it’s a safe bet that many other participants who are also positioned long are feeling your pain. Everything you feel, see, think or perceive is shared by multitudes of other traders. In its essence speculation is the front running of orders. Your job is to buy or sell before other buyers and sellers auction the market into new valuations. Always be cognizant as to who is in control. If the market is tanking there’s a higher probability that longs will be anxiously selling into thin bids than shorts feeling compelled to take too soon profits.

While trading is a lonely individual pursuit there’s little emotional uniqueness in the price discovery model. Take comfort that those adrift moments are universally shared but that unlike the party goer who is too drunk to find his way out of the nightclub fire, you’ve already checked the exit route just in case the worst does indeed occur.

Kurt J. Eckhardt has been trading since 1982 when he began his career as an active floor trader in the CBOT Treasury Bond pit. Kurt is President of Eckhardt Research and Trading and its subsidiary Agility Trading. Agility offers both individuals and funds cutting edge technical strategies along with high performance instruction. For more information go to www.agilitytrading.com or email Kurt at kurt@agilitytrading.com.