Position Sizing and the Bigger Picture
05/09/2013 6:00 am EST
The benefit of position sizing is to help you predict and manage your risk, and Marc Principato of SMB University Forex Training Program shares some tips on how to scale into positions.
You know when you get up in the morning and open your charts and see your pair has already moved enormously without you? Ever wonder how to participate in that? You look back at your smaller time frames and see a setup on a 15-minute chart, but you had to be up at 4:30 am ET and watching for hours in order to recognize and participate in that setup. So how is it done? Should you invest in a robot so that you don't have to worry about watching the market 24 hours a day? By now you should know the long-term results of a retail robot, and in case you don't, they are not pretty. Instead let's consider what it would take to participate in “the bigger picture.”
One of the simplest ways to participate in the bigger picture without losing sleep at night is to adjust our size to an amount that is very comfortable for our psychology and is proportional to our account size. For example, if I am going to begin a position on the EUR/USD, I will start with just one mini lot. I know what you are thinking, “So if it goes 100 pips your way, that's only 100 bucks! Pocket change!” Here is what you may not realize: This is my starter position. Remember, if I am getting involved, it's because I recognize structure on a large time frame that implies price stability. If I have determined that my larger time frame trend is bullish, then I want to get involved in a small way. Why? Because we know these things fluctuate wildly at times and how do I know it's going to start moving my way now? It may not make the real move until the next trading session, which can take hours. So I start small with the intention of adding to the position, whether it is in my favor or against me.
Here comes the conventional defense mechanism. You immediately say to yourself, “Hey never add to a loser.” The question you have to ask yourself is, if I am averaging into a position over a large range of prices that show evidence of a trend, and my risk is well within my acceptable limits, then am I really adding to a loser? Or am I distributing my risk in a controlled manner? If I am wrong overall, I have a stopping point, which will be less than 2% of my account. If I am right, I have the opportunity to add to the position, which puts the reward to risk ratio in my favor.
Even though participating in the bigger picture requires more patience and taking some pain, it also better allows for being in the trade when the market has one of those elusive big moves that come out of nowhere.
Most importantly, successful trading comes from good money management and proper position sizing is a part of it. In the long run, analysis only serves as a basic guide. Getting caught up with indicators and reading news all day will not help you become a more effective trader. It's all about risk control and perspective.
By Marc Principato, CMT, Director, SMB University Forex Training Program