I realized lately that I have an irrational fear of size. Going into a trade with the appropriate amount of capital still scares me. It shouldn’t however, considering I have strict rules, a set plan, I cut losses quickly, and know my risk/reward ahead of time.
It’s the downside risk that makes me avoid full position size. Some part of me thinks that the first time I go in with the appropriate amount of shares, it will happen to be one of the 29.2% of trades that go against me. I’ll look at the P/L, freak out, and then go partial size the next trade, which will be the one that works out, leaving me with a net loss between the two.
This of course is silly—at a 70.8% success rate, I could just up the size of my trades across the board and be fine, making greater profits in the process. Of course, making more money per trade also means possibly losing more money per trade. To cope with the irrational fear of greater potential losses, I talk myself into believing a trade is riskier than it is. For some trumped-up reason in my rationale (“the news is sketchy”, “I don’t like the time of day”, “I’m traveling”, “there could be an offering, they need cash!”), I decide to only buy half or a quarter of the shares I normally would. What follows naturally is that the trade works out, I get my 50 cents/share profit, but only make $200-300, instead of $500-$1,000.
At some point, I also arbitrarily decided that 1,000 shares is full size—only if the stock is below $1, will I take several thousand shares. I think I based my initial decision off of a $50,000 account (w/ 1k shares at $10/share, I’d be in with 20% of my account which made me comfortable at the time). I should, in theory, base my size off of stock price, the quality of the trade, and account size.
That said, I decided recently that I need to up my game—not to hit certain profit targets (always a bad idea IMO), but to achieve more of my potential, more of what I could achieve (I was tempted to say should achieve, but the market doesn’t owe me anything).
If you haven’t checked it out yet, you need to watch Tim Sykes’ free DVD Trader Checklist. You can watch it online for free here: http://traderchecklist.com/
Tim lays out what is essentially a points system for evaluating potential trades. Using certain variables, Tim comes up with a score (0-100) for each stock he’s watching—the higher the number, the better the setup. I’ve been scoring my own trades since the DVD came out, but aside from a binary, “trade or no trade” decision, I haven’t done much else with the score
Inspired by Trader Checklist, I’ve come up with the following solution to my size issue. Based on the checklist ranking of a trade setup, I’m going to go in with certain, pre-set sizes. If the scores below don’t make sense, go watch the DVD.
85-100 points = full size (1000 shares)
75-85 points = half size (500 shares)
65-75 points = partial size (250 shares)
<65 = no trade
Note: This, of course, is a work in progress and may change as my experiment plays out.
I have no idea how this will play out, but I’m willing to try it. If it doesn’t work, I can always go back to second guessing my risk and trading small. What are your thoughts on this issue? Do you think my solution is too rigid? What have you done that works? Please share what’s worked for you.
EDIT: After posting and speaking to a few traders, I realized that my numbers are too conservative. I think the below is a better plan (assuming a stock price under $10):
85-100 points = full size (2000-3000 shares)
75-85 points = half size (1000 shares)
65-75 points = partial size (500 shares)
<65 = no trade