When I first started trading more than a decade ago, I thought trading success was about being right - knowing when to
enter the market and milk some money out of it quickly.
Pretty soon the markets taught me that this was not
the right path to follow!
I slowly started shifting my mindset from being
right to simple probabilities: I was not concerned about being right or wrong
anymore, but rather about how much I lost when the trade did not work and how
much I made when the trade was profitable.
But 3 years ago, when I started designing the
top-notch trading algorithms we are now using in our hedge fund, I wanted to go
even further, so I turned my attention to an even higher level of risk
management - based on the question:
What is the right position of my trade at any given
moment?
Initially, we developed a special testing platform
with the head, a programmer in my hedge fund and started testing an endless number
of ideas to find new techniques for position sizing. The idea was simple - the
higher the chance that the current market conditions were in our favour, the
greater % of our capital we should risk (the more futures contract we should
trade), and vice versa.
We had quite a lot of fun testing all our ideas and
some of them were cool (yet pretty simple). Eventually, the testing led us to
an even bigger idea we used to build our proprietary position sizing
"brain" we called "Trading Director", but even if you are
not at the phase of building your own hedge fund (yet), there are still plenty
of simple ways you can use this approach and start testing advanced position
sizing techniques.
Here a few simple ones you can test today:
1. The day of the week matters - Some days of the
week have much stronger results than others, therefore, you can adjust your
position size accordingly: On some days of the week, you can increase your
position by 25, 50, or even 100% (and on some days you should decrease the
position size too).
2. The previous day's action often helps - The way
the market traded on the previous day often matters. Just analyse what your
trades look like when the previous day was an up day, when it was a down day,
when it was a low-volatility day and when it was a high-volatility day. The
previous day's action can be correlated with the quality of your entries;
therefore, you have another great opportunity to set the size of your position
accordingly.
3. An opening gap can make a lot of difference - In In some markets, a large gap can mean that there might not be enough space for a
further movement in the gap's direction, therefore, analysing whether the current trading day opened with a gap, in which direction, and in what size,
can be another effective way to determine a more appropriate position size for
the given day.
Of course, there are many more techniques to
explore, but these 3 are pretty good and are safe to start with. The more you
experiment with different position sizing methods, under different market
setups and conditions, the more interesting the results.
And if you really want to get advanced with this
concept (which I highly recommend), then one of the best ways is to
use Market Internals to analyse market conditions. This is one of the
techniques we are using in our hedge fund and this is also where you can start
seeing some fascinating possibilities.
Happy trading and happy position sizing!
Article by Tomas_Nesnidal
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