the “ALL IN” Gunslinger – part 2 – maxing out your trading account WITH risk management and position sizing
In part one of this series we the addressed short comings of moving your account “ALL IN” on a single trade. We acknowledged that yes – it can be done but at your own peril. If risk management and discipline are our ultimate objectives when trading (and it should be for every trader) then 99% of the time you will find yourself having to set stops so tightly in order to adhere to that ultimate objective (risk management) only to have the market “whipsaw” you in and out of trades. The stops by default HAD to be set as tight as they were (in the hypothetical example from part 1 of this blog) because of the conscious choice to max out my trading account on an “ALL IN” trade. Let’s say for example you normally would trade 250 shares of XYZ stock and as a disciplined trader you would immediately place a -2 point stop in the event things didn’t work out in your favour. A losing trade would result in a -$500 loss before slippage and commissions. This time however, you decided to become aggressive, focusing only on the upside of this trade (which is the mother of all trading mistakes) and you placed an order for 2000 shares.
risk management and position sizing using m3 - Money Management Modeler
http://www.screencast.com/t/cfkVicwjwD (Click to enlarge)
It’s nice to visualize your profit potential – but is there any guarantee that this particular trade will be a winner just because you decided to go “ALL IN”? Absolutely not! Let’s play devil’s advocate for a moment and assume the trade was a loser. Your -2 point stop is hit (kudos to the trader who placed a stop loss order given the fact many traders DON’T!) and now what could have been a manageable -$500 loss is a -$4000 loss (-2 points x 2000 shares) OUCH! I suppose this is ok if you have a trading account balance of approximately $400,000 but then if that were the case, this wouldn’t be an “ALL IN” trade you probably could have afforded a lot more shares. Let’s assume that this is a modest $40,000 trading account. That -$4000 loss just crippled your trading account balance by -10% in a SINGLE TRADE! One of my favourite sayings (and this one I made up personally) goes like this ….
“Just because you can pay for a trade doesn’t mean you can afford it”
This is why position sizing is CRITICAL to long term trading success. I have not even mentioned the psychological toil you go through when a TOO large position begins to move against you. Often times traders cannot accept staring at a -$3000 or -$4000 loss and they end up abandoning the stop loss all together. Do that and you are on a slippery slope to …. well, I’ll let you finish the saying. I hate to admit it but –“been there and done that and I ain’t going back” . Enter the m3 – Money Management Modeler
I left off part 1 of this 2 part blog saying that going “ALL IN” with your trading account balance is not only possible, its ideal – just not on a single trade. I regularly go “ALL IN” each day with the money at my disposal over multiple trades. My risk management is sound and practical with each position I open allowing for calculated stop losses that won’t “whipsaw” me with each tick. Yet if I am to be stopped out, the loss represents a predetermined and acceptable risk to my overall trading capital. The m3 platform calculates these values numerically and shows you visually through the use of dynamic graphs.
Fear - not the ideal emotion when trading
The modeling capabilities in the heat of a trade are invaluable. I can control the percentage risk per trade to my account balance by modeling any combination of variables such as adjusting my stop loss; reducing or increasing the number of contracts or shares I am considering which will in turn alter the amount of trading capital I am committing to any single trade. I can now decide whether I wish to model my returns based on a CASH trade or on a MARGIN trade. Finally, with my latest upgrades to the m3, I can model out my returns on a leg by leg analysis. Prior to these latest changes a trader would be analysing returns on the assumption that your most optimistic profit target would be reached (usually that is your profit target or leg 3). Now with the quick click of a button on I can see what the return on my “at risk” capital AND my entire trading account would be on profit targets 1, 2 and 3 individually. When implementing the “ALL IN” approach by trading multiple positions it is CRUCIAL to have a tool that can quickly show you exactly the weight of the position relative to your trading capital, the risk in percentile terms to your trading capital and on the dollars committed to a individual trade should the it turn out to be a loser and returns that will be realized as each successive leg is reached should it turn out to be a winner. The m3 – Money Management Modeler does it all and more by allowing you – the end user to manipulate, model and analyze your individual particulars on the fly with 100% confidence that you are protecting your most valuable asset – your trading capital. Built within the Excel platform, m3 is THE tool for serious traders who wish to have control over the only thing that we can in the markets – how much you’re willing to lose.
Fulcrum Shift Trading
Tags: position sizing, risk management, stop loss calculator, stop loss software