When I first started trading over a decade ago, I thought trading success was all about being right: knowing when to enter the market and getting some money out quickly.
Very soon the markets taught me that this was not the right way to go!
Little by little I began to shift my mindset from being right to simple probabilities: I was no longer concerned with being right or wrong, but with how much I lost when the trade didn’t work and how much I made when the trade was profitable.
But 3 years ago, when I started designing the world-class trading algorithms we now use 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 correct position of my trade at any given time?
Initially, we developed a special test platform with my hedge fund’s lead programmer and began testing a myriad of ideas to find new techniques for position sizing. The idea was simple: the greater the chance that current market conditions are in our favour, the greater the percentage of our capital that we should risk (the more futures contracts we should trade), and vice versa.
We had a lot of fun testing all of our ideas and some of them were really cool (but pretty simple). Eventually, testing led us to an even bigger idea that we used to build our proprietary position sizing “brain” that we call “Trade Director,” but even if you’re not in the phase of building your own hedge fund (yet) There are still plenty of simple ways to use this approach and start trying out advanced position sizing techniques.
Here are some simple ones you can try today:
1. The day of the week matters – some days of the week have much stronger results than others, so you can adjust your position size accordingly – some days of the week you can increase your position by 25, 50 or even 100%. (and some days you should also decrease the position size).
2. The previous day’s action often helps: How the market traded the previous day is often important. Simply analyze 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 to the quality of your entries, so you have another great opportunity to size your position accordingly.
3. A gap to open can make a big difference – In some markets, a large gap can mean there might not be enough room for a further move in the direction of the gap, so look at whether the current trading day opened With a gap, in what direction and by what size can be another effective way to determine a more appropriate position size for a given day.
Of course, there are many more techniques to explore, but these 3 are pretty good and safe to start with. The more you experiment with different position sizing methods, under different setups and market conditions, the more interesting the results will be.
And if you really want to move forward with this concept (which I highly recommend), then one of the best ways is to use Market Internals to analyze market conditions. This is one of the techniques that we are using in our hedge fund, and this is also where you can start to see some really exciting possibilities.
Happy trading and happy position sizing!
Thomas
This article was originally published on the Better Trader Academy blog!