I hate to break this news to everybody, but size does matter when you are investing or trading. It is one of the most critical aspects of sustainability and long-term success when making money in the markets — especially in markets like we’ve seen over the past month.
We’ve been conditioned to believe that, in order to make money in the markets, one needs to “Go Big or Go Home!” And unfortunately, new investors often fall into the trap of thinking that.
Well, what I have witnessed over my 23 years of trading is that, yes, there are some people who kill it by going big, but there are a hell of a lot more people who go home with no money!
It took me a very long time to figure this out.
I lost everything when I allowed other people to manage my money in private equity deals. It made me realize that there had to be a better way — a better way to make money consistently without taking massive risk all the time.
When I think about it logically, I traded way too large and took on way too much risk. I thought I could handle the risk, but when managing your own money, and money for OTHER people, you need to be focusing on taking care of the downside because the upside will always take care of itself.
Worse… if anything went bad with a single trade, I would be hurt, let alone if all the deals went bad; which they unfortunately did! An anomaly, or what we call in my world a black swan, can ruin several months worth of gains. Though considered “RARE,” (really, how many black swans have you seen in YOUR lifetime?) black swans happen more often than you think.
For some reason, traders lose sight of what they are trying to accomplish or have unrealistic expectations of what they can, and should, be making when investing. People tell me all the time that they tried investing in stocks, options, and futures and they lost all their money.
The two main reasons people lose money is because they lack specific knowledge and they TRADE TOO LARGE.
It is simple. Our main goal should be capital preservation, first and foremost.
Why? It’s simple. We work hard at jobs we don’t like or put extra money aside to invest. Our intention is to invest that money until we DON’T have to work those jobs we hate.
Our extra capital is precious because, if we lose that, we would need to go work our asses off at the job we really don’t like to make it back.
Though I tell people all the time that the retail investor has great advantages over the Wall Street Traders, this is the ONE advantage that Wall Street has over Main Street — they have endless access to capital where the average retail trader doesn’t.
Trading small is key to risk management.
The “trade small’ philosophy comes from the fact that you never want one position to ever destroy, or blow up, your portfolio. When people ask me, “Well, then. How do you make money?”
It is quite simple. Trade more!
This is so relevant to an option trader, like me. I use probability and statistics to gain an edge in the market. But anybody who is looking to make money consistently, MUST LEARN to trade small.
This strategy gives you the ability to stay in the game and never be in a situation where you can lose everything (or a significant part of your net worth). Plenty of new traders argue with me about commission costs; and I laugh.
First, commissions are the lowest I have ever seen them, and second, we are not talking about day trading or trading for the sake of trading.
We are talking about finding a lot of very high-probability trades. This is defined by a trade that has a better chance of profitability than of loss. The KEY is to enter the trade, risking a small enough amount of capital that even if all the trades went wrong, your trading account would still survive.
The probability of all your trades going bad all at once is extremely low, but still a possibility. (Remember the Black Swan?)
The “trade small” philosophy also gives new traders and investors time to figure out which strategy is best for their portfolio and how to run their strategy. You need to stay in the game long enough to figure out what works and how to make it work long term.
Be logical. Many new investors think they have the best trade in the world, and they put half their money in it and it goes down immediately. They end up losing more than they expected they would (because their cousin’s friend’s brother trades options and KNEW this was a winning trade).
And then it happens again (because you didn’t learn the FIRST time that your cousin’s friend’s brother had no clue when it came to managing risk and picking winning trades) and usually, you’re done by then.
Or, you see something like Bitcoin and with FOMO(Fear Of Missing Out) kicking in, you get in (and usually get in too big) and well then there’s a high probability that ALL the MONEY IS GONE if the trade goes wrong.
Trading small also gives new traders/investors the ability to pull the trigger! So many green traders learn to become great paper traders but when it comes down to making that first trade, they are scared to death.
My recommendation is to trade small enough so it doesn’t affect you and obviously if you can use a defined risk trade, do that. This takes the fear away and lets you see real money at work.
You see? Size DOES Matter!