Sunday, August 10, 2008

Position Sizing: Finding Your MAX Pain

Position Sizing(P.S.) is a very important part in trading survival. Improper P.S. can lead to overtrading, taking tiny profits while letting losing trades run against you and turn into huge losses. In short, if not done well enough to fit your level of comfort it will lead to EMOTIONAL TRADING. Which is the single most biggest enemy to a trader.

In my opinion, P.S. is where trading becomes an art. Every trader has their own level of comfort and pain. If i am managing a portfolio worth $100,000 and i take a $5000 loss on a trade, then i will get emotional and start to notice changes in my behavior in front of my computer screen. I will start to curse, sweat from my forehead a little, pace around the room or start to desperately scan thru my stocks to find the next trade that's gonna 'get me out' of this loss. lol! Never 'gets us out' does it??!!
If anything, that loss will likely get bigger.

Position sizing is about treating every SINGLE trade on it's own merit and you MUST have a MAX pain stop loss in mind before that trade is executed(and always have a profit target). Having said that, my max pain loss is different then yours. EVERYBODY's MAX PAIN IS DIFFERENT!!!! Also, my max pain stop loss is different when i am in a winning streak(my max pain stop loss tends to increase after a nice winning streak) and vice versa in a losing streak(i tend to be very chicken and cut losses very quickly when i am trading like shit).
TRADING IS AN ART! Not a science in my opinion.

The key is to figure out a number, a stop loss figure, that once it gets hit, you'll admit you are wrong, sell the position and move on to the next trade without affecting your emotional state of mind. If you feel emotional after that loss, then you have likely crossed your MAX LOSS PAIN you are now trading on desperation to recoup that loss and you are trading to get even rather then focusing on nailing the next trade and placing that ONE TRADE that's making your mouth water.

During winning streaks where my mind is at ease, i am seeing moves in "3D" and i am executing trades when i am in "the zone" and i am moving from one winning trade to another with flawless execution then i will tend to get very aggressive with my position sizing as the market is likely VIBING WITH MY STYLE (I am trading in my comfort zone) and i can put up to half my account in a DAY TRADE. My comfort zone is a momentum market, a runaway market which is setting up Holy Grail Setups, Wedges/Flags patterns and volume is rampant and stocks are closing on their highs/lows on heavy volume.

I like to think of myself as a disciplined trader: when i am not vibing with the market and i am making bad market calls or choosing poor stock selection to maximize the current market's behavior then i will stop trading all together. When i do place the trade, i will test out tiny positions to see if i am "seeing em right." If not, then i will go on trading probation and hibernate until the tides turn back in my favor.

Personally, my MAX PAIN on any position is $2000. I rarely put more than $200,000 in a stock idea. I usually average between $100,000 to $150,000 on any single day trade, AVERAGE $125,000. So MAX LOSS of $2000 and an average of $125,000 in a single trade, you do the math. I can eat a $2000 loss and move on in a non-emotional state of mind to hunt down the next winning trade.
Obviously i am shooting to be down as little as possible. This is where THE IMPATIENT TRADER in me comes in. I know that winning trades work almost right away. A trade that is fighting me early on or is not moving within 10 minutes after my entry will likely NOT WORK and TURN INTO A LOSER! I repeat, your style and your max pain will be different! I CANNOT STRESS THAT ENOUGH. You need to find your comfort zone.

I am mostly a day trader but i do Overnight Holds on some trades. Depending on my confidence level, the size of this trade will vary greatly. Can go from 500 shares to 10,000 shares. This Is Where Trading IS an ART. Getting a feel for your trading will require you to TRADE and finding out what kind of trader you are, what is your MAX PAIN, what kind of market condition will make your mouth water. Trade only when you are thinking rationally, not emotionally.

Good luck.


fjords said...

Great post! Thanks.

Rick said...

Thanks for taking the time to post that. I think it's possible to increase your "pain threshold" over time by gradually increasing your size like turning up the heat on a boiling frog. I heard an interview with a professional poker player and she said the first time she lost $1000 in a game she was devastated. Then it took $2000 to bother her, then $10,000 etc...

Anonymous said...

stewie. I always appreciate when a pro gives the general public words of wisdom. I try and soak as much of it up as i can. and i do feel it is working. thanks Bill

Anonymous said...

stewie.. thanks for sharing ,i would like to know how much your max loss per day .if the first and secound were losing trades , when wouldyou stop trading for the day?

Stewie said...

Sam: my daily MAX PAIN is $2000. losing more than that and i would consider that day a bad one.

Blue said...

Stewie, my last comment didn't make it so I'll repost some of it and elaborate on this topic if I may.

I mentioned that I realized last week I was still scalping during trending days (over the last two months). I got so stuck in scalp mode in a mixed market on some very choppy days that I chased every winning trade with a tight stop. Then we had a few really good trend days and I was trading the same thinking it was my fear of trading larger sizes, but in reality I was stuck in scalp mode. Of course I got stopped out minutes into really good trades for 10% of the profit potential every single time. Sometimes I stopped out more than once knowing the trade was good but too scared to take ANY loss AT ALL. Then I'd beat myself up over and over for being so stupid to not stay in those trades. I was so concerned with loosing $125-$250 before letting any trade work and in the process giving up $1.5k - $3k on those trades.

It's important to find out early (the first 30min to 1hr of the market) if there's a trend that day, what it is, what stocks are following it (maybe a pair trade) and get in a trade or two. Have a mental stop and ride it out until you get some wiggle room to put an in the money stop. Then set it and forget it, or chase the stop up until the pattern breaks. I have yet to have a stop loss save my ass from a bigger loss on a day trade. Quick stops are always profit killers for me, unless I know I'm just scalping a quick trade with a tight stop. There's a huge mental diff. between intentionally scalping a trade, or playing a trend.

My Rimm trade on Friday was a huge learning lesson for me. I shorted Rimm @ 126 on Thurs. on some late weakness. I held it overnight knowing 126 was a safe price. I missed my exit at 125.75 at the open thinking anything under 126 was a sure sign of weakness. I saw the HUGE buying in Apple and knew I had to get out of Rimm. I covered at 129.75, and went long for 500 shares at 129.50. Stopped out 129.60. Went long again for 500 shares at 129.50, stopped out 129.52. Went long a 3rd time for 1000 shares at 129.45. That order didn't fill quick enough so I yanked it and gave up fearing I would just add to the loss (it hit 129.43 1min later). Rimm held the 20sma on the 5min chart (HG set up) at 129.50 then broke through 130 and never looked back. I figured it was good to 137, it hit 136 and ended the day at 133. I actually went short at 132.50 for 1,000 shares at the very end of the day expecting some profit taking and that didn't happen either, but at least I gave it another shot and didn't give up completely.

Had I not played those stop loss orders after my order entry on a trending stock I would have had my entire loss back + profit to end the day and profit on the year after a 2.2k loss on SOHU in June. I think it just takes going through this to learn how to lose the emotions, trade calmly, and trust yourself confidently. I can't learn how to trade 100k trades without going through this process. To me it's a tuition. I'm spending a little in order to set myself up for success on the next big trade. I've learned how to manage the $250-$500 trades. I've been working hard now to lean how to do the same thing on a much larger scale. If -$3.5k on Fri. is what it cost, so be it. Time to Stewie size things on good days! Do nothing or trade small on the other days. I know I'm close because I've never felt more empowered.

Anonymous said...

I wish to add my “thank you” for your generous analysis that I always find so amazing! --Jim

Gio said...

Hey Stewie, thanks again for this post! Knowledge is more valuable than any stock, and that's why we blog... to learn from each other. Anyway, I posted this on iBC.

Stewie said...

gio: thanks for linking me and your support. you are the man and i love reading your posts on ibc. keep up the hard work. peace bra.

Stewie said...

blue: you are getting so close. love your self awareness as a trader.

Stock Gunslinger said...

thanks for this post. i have struggled more with discipline than with anything else. I was the king of moving the stop until I reviewed those trades and found out how much money it cost me.

i interviewed trader/psychologist Denise Shull recently and she made some excellent points about discipline. I will post the interview to my blog tonight (Wednesday).

Thanks again for this post!!!

MatchPointTrader said...

Thanks a lot Stewie. I am still learning and this post was really useful - yet written in a simple and understandable manner.

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