Risk Limits.

Part One

In this post I want to talk about risk limits in trading because it’s an important topic that really has no correct answer to it.

A few weeks ago I discussed the mental model shift that I was making and part of that is with risk limits on trades.

When I left the last role at the fund I was with in 2014 there was this training I made for a few folks that took off.

It was called ‘Remora Options’ now called Small Account Tactics.

Basically the story was that made about $300K over the course of about 15 months using a $50K account and a risk model that was pretty tight.

The risk model in there was teaching a maximum of $1,000 per trade and to hold for larger moves.

So where a trade would be say $50 it could go to $250 (as an example).

What that does is allow you to be loose with your stops v. say buying $10,000 of a position with a 5% stop you can trade less size and have a wider stop.

Now that’s ideal for a lot of traders who are new or investing smaller.

But I could have made a lot more during that span.

I didn’t, however, because I kept my risk per trade capped to $2K - meaning that I never bought more than $2K into a position.

It worked then to trade a small account but that mindset creeped into my other strategies and had me leaving money on the table.

This is a really great quote that has always stuck with me:

After a while size means nothing. It gets back to whether you're making a 100% rate of return on $10,000 or $100 million dollars. It doesn't make any difference.”

And he’s right. It doesn’t make any difference, it’s all the same. And when you get to a certain point you have to size up.

But there are things that I disagree with when it comes to this topic of risk.

• The percent of account per trade/investment idea is not something I have ever agreed with.

• Also - I don’t agree that each strategy or asset class should use the same risk model.

For example.

If I am trading something say in the Momentum Monitor that risk might be higher with a tighter stop v. me trading E-Mini futures for a scalp.

There’s also a risk model for equities and say a ‘Core Position’ - the way I use that is really a max 15% of the portfolio.

So if I want to buy Schwab and I am running say $1,000,000 then the max size/risk is $150,000.

So the risk varies and it has to.

If we’re talking risk at a 30K foot view - I like the asymmetry on ES futures options and equity options better anymore than I do on actual futures.

It doesn’t mean I won’t trade E-Minis anymore but to justify any size on the trade it has to be just a REALLY good situation where we’re going to move a lot (meaning 30+ points).

How do you know when it’s a full risk/size trade?

I talk about this a lot (or have) in DeltaOne - mainly because folks in there have larger investment accounts and we’re after outsized trades but I’ll share a little here.

Every trader needs to have a playbook and you need to find what trades work best for you and understand why.

Based off of that you’ll know how to size the position.

Now, I’ve seen this a lot in retail trader and in my opinion, it’s foolish but I’ll say it.

The idea that you are going to find some trade setup that has say a 85% “win ratio” and trade that over and over is ridiculous.

Not every situation in the market is the same - ever.

So reading the current market sentiment, the trade you’re about to take and then also looking at your MTD or YTD returns are things I do.

For example.

If I am up over my quarterly goal and I get a B+ trade set up I might size it heavier because I can afford to press it.

If my goals are not being met then the size of the trade is ‘normal’ or less than it usually is.

If you’ve been reading the report lately all I've really been discussing is NVDA and two other names.

Why? Because in these situations, the read + sentiment + setups mean that, to me, they are A+ trading opportunities.

And when those come a long I want to extract as much as I can out of them.

But again, this is SPECIFIC to a situation and this is one of the reasons I don’t like the ‘trade setup win ratios’ or the percent of account rule; it leaves ZERO room for discretion and you need that in trading if you want to do this at a high level.

This idea here - extracting the gains from the trade/situation took me a long time in my career to realize.

And now that I’ve realized it I make it a point to make as much as I can from A+ situations.

This is part one on Risk - I am going to get into managing a trade as part of the risk process in the next post and what goes into that for me.

Thanks for reading and if you have comments/questions please leave them below!

Dan

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This article is presented for informational purposes only, is an opinion, is not intended to recommend any investment, and is not an offer to sell or the solicitation of an offer to purchase an interest in any current or future investments. Any such solicitation of an offer to purchase interest will be made by a definitive private placement memorandum or other offering documents.

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