If you are too big a “gambler”, you will end up out of the game!

One of the secrets of success common to large traders is that their trading method includes “low risk” trading ideas. Low risk trading is an idea that is traded at a risk level that allows you to survive the worst-case scenario that can happen in the long run so that you can still achieve the long-term profit expectancy of your trading method. This is one of the most important key rules for successful trading. You may have the best trading plan, information, and a good performance system, but if you are too big a “gambler”, you will end up out of the game. As a trader you are without a doubt going to encounter losses and it is of great importance to limit the damage of these losses to make it possible for you to achieve a cumulative return on your trading capital.

Properly determining the size of a position is the most important component in risk control, it is a critical part of the trading method that will determine if you achieve your goals.

In many cases the failure to make money simply occurs because the person has risked too much money. The excessive risk comes from psychological reasons, failure to understand the chances, and in some cases even the desire to fail. In any cases, mathematically the losses happen because too much money was risked.

Basically, the position size is the part of your trading method that tells you “how big” a bet can be at any given moment throughout the life of the trade. The answer to this question is crucial for most of the variables that determine the final performance of a variety of professional traders. And yet most traders in the market have no idea what to base their position size model on. Even experienced traders who know that determining the size of a position is important and understand that a logical solution to the question of how to do it is to establish the “size of the bet” considering their size of capital, most of them do not have the appropriate knowledge of how to really do it.

Many traders believe that they are doing a decent job by using a “risk management” stop, which is a Stop where you step out of a position when you lose a pre-determined amount of money – say 1000$. At the same time, this type of stop does not say “how much”, so it has nothing to do with determining the size of the position. Control of risk by determining the size of the loss if you are out of the game is not the same as controlling the risk using a position size model that determines “how much” or if at all you can afford to hold. In the process of answering the question “how much?” you will have to consider matters such as what to invest in and risk control, but these issues are not part of the “model” for determining the size of the position.

Finally, it is possible to have a unique trading method and a high profit expectancy and a good model for determining the size of the “bet” and still lose money. It takes the ability to execute the decisions that are made, which is something a lot of senior traders fail in time and time again, you must feel comfortable trading the size of your position no matter how big it is.

Writer: Edo Harari, Chairman of Circle A Capital.