GO BIG OR GO HOME!
Is that a good saying when it comes to trading? Let’s find out!
Today we’re going to continue our investing series called “Where are my gains?” with Sin #2: large position sizes.
If you think trading stocks is easy or will result in overnight riches, then you’re sorely mistaken. This is also typically the hopes and dreams of beginner traders, and they very quickly learn the hard way.
If you’ve watched my video on dollar-cost averaging stocks, then you know that even professional money managers have a hard time beating benchmarks like the S&P 500, especially consistently over longer time periods.
So if professional money managers who work on this as their full-time job have a hard time making the best calls, what do you think your chances are?
And this is exactly why position sizing is very important when you’re trading.
What is position sizing in trading?
Let’s take a step back and explain what position size means.
Let’s say the total bankroll that you want to start trading with is $10,000.
Every time you open a position, and this holds especially true for traders who hold short-term positions, you only want to use a small percentage of that bankroll, such as 1-3%.
Let’s nail this down with an example. And keep in mind that we’re talking about trading, not long-term investing.
Our trader is in the stocks, options, and crypto markets. However, he sees crypto as a speculative investment, so he decides that crypto will only take up 10% of his total bankroll of $10,000. So at most, he will invest $1,000 in crypto.
Of that, he can decide that he wants to trade with leverage in Bitcoin futures. Since leveraged futures investing is risky, he’ll only use 3% of that $1,000 that he has allocated towards crypto, which means that each position he opens is only $30.
If the worst-case scenario happens and his Bitcoin futures position gets liquidated, then he’s still in the game because he only lost 3% of his total crypto bankroll.
On the flip side, if he didn’t practice smart position sizing, and he said to himself “Man, $30 is nothing! I’m going to make peanuts on this. You know what? I’m going to go big and just put $1,000 on this ONE position.”
If the same liquidation event occurs for this trader, now he’s completely out and he’s already down 10% of his total bankroll.
Large Position Sizes = Greater Emotional Response
In the scenario where you use large position sizes, it will also trigger a much higher emotional response and will likely result in more irrational trading behavior, such as thinking that you can double down and make back what you lost.
Emotional trading is your worst enemy and your emotions will definitely come into play if you’re trading large positions.
On the flip side, when you are using smart position sizing, you’re not going for those home-runs. You’re going for those base hits that add up gradually and grow your overall portfolio and bankroll.
And because you’re only using a small percentage of your total bankroll for each open position you’re trading, your emotions have a much lower chance of getting the better of you, which typically results in more profitable trades.
If you want to stay in the trading game, then your bankroll has to be able to last you through the ups and downs of your trades.
There’s no go big or go home if you want to trade in the long-term because trust me, you’re going home.
So now I’ll leave you with a popular saying within the investing community that is usually for long-term investing, but I think it is pretty relevant here too. It goes “Time in the market is more important than timing the market.”
If you enjoyed this video, then I would love it if you Subscribe to my YouTube channel.
This is Alan signing off and sharing with you Sin #2, Large position sizes, in our series called “Where Are My Investing Gains?”. Here’s to you investing in your knowledge and future – I’ll see you soon.