Best Trading Practice: Rule-Based Sizing of Positions

 

A great deal of the success of a trade comes from what happens after the position is put on.  The best traders I've worked with have rules for managing positions, not just putting them on.  They have rules for stopping out of positions; rules for holding positions; and rules for adding to positions.  Their rules allow them to get out quickly if their ideas aren't playing out, and their rules allow them to go for it when the trade is working.  Being brave enough to start and put positions on is necessary for success, but not sufficient.  It's when we're strong enough to finish and take maximum advantage of our best trades that we achieve our true success.

For last week's trading psychology workshop, Henry mailed me his best practice and gave me permission to share it with readers.  He explained that "William O'Neil, Mark Minervini, and Lee Tanner inspired me to trade a bigger position when you are winning.  'Look for add-ons'.  First of all I try to get in with an initial buy as close to my buy point as possible...After the initial buy, my best practice is that I buy 20% extra (of my whole position) every time the stock makes a new high after a correction of minimum 5 trading days...All my buys have a stoploss of -8% below the buy price.  But every time I get stopped out, the followup buy is 10% bigger than the previous buy...I trade only by written rules".

What makes this approach effective is that it benefits from parabolic moves in the stock being traded.  Finding the right stocks that are trading with momentum is thus important.  A large part of trading success comes from the relatively few occasions when you're getting bigger and bigger in your best opportunities.  What he learned from mentors was "to trade a bigger position when you are winning" and "look for add-ons".  Success requires risk management, but also requires opportunity management.  Having rules for protecting capital and also rules for maximizing your best ideas allows for good starts and solid finishes.  Many traders fail, not because of a lack of risk discipline, but because of a lack of opportunity discipline.