Assuming that you’ll be able to increase your position size rapidly, or even steadily, growing your income may pose more problems than you expect. Account size permitting, position size should be increased incrementally, so as not to trigger anxiety or other emotions that could be detrimental to trading performance.
Position Sizing and Profits
There are basically two ways to make more money from your trading:
- You can continually make a higher percentage return on the position size you typically use. Basically, get better.
- You increase your average position size as your account grows, so you are making more dollars due to the larger position sizes.
Increasing percentage returns is good. And that comes from reducing mistakes and implementing a strategy better. Improving percentage performance is definitely one way to squeeze more money/income out of the account.
But, most traders also want to grow their account, and as their account grows, they increase their position size in order to keep similar percentage returns.
For example, if you typically put $2K into a stock and you have a $10K account, let’s say you make 50% per year ($5K profit on the $10K account).
The next year you have $15K. If you keep only risking $2K on each trade, you will probably make $5K again (if conditions are similar). That is only a 33% return on the $15K account. Your position size didn’t increase in step with the account size, so your percentage return drops.
In the first example, your position is 20% of your account balance (2K/10K). In the second example, the position size is 13.3% of the account balance (2K/15K).
Ideally, as the account grows we also want our position size to grow. This way can keep our percentage returns similar even as our account gets bigger.
To keep risking the same amount, once the account is at $15K, our position size should increase to $3K. If all goes similarly to last year, then we will likely get our 50% return again.
The same concept works if you risk 1% of your account balance on a trade. On a $10K account, you risk/lose $100 per trade. By doing that maybe you make 40% for the year (insert whatever percentage your strategies are capable of producing). The next year your account is $14K. You can now afford to risk $140 per trade (1% of the 14K account). Keep risking $100 per trade and your percentage performance will likely go down.
Increase your position size in step with your account growth. Do this as long as you can. But eventually, you may hit barriers, where the position size starts to cause anxiety.
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The Problems of Increasing Position Size
We want to increase our position size. If our strategy produces 30% per year, we want to be trading as much of our capital as we can, in a risk-controlled way, in order to achieve that 30% return. If we trade a smaller position size than ideal, we will make less than we could have (in this case 30%).
For example, the long-term return of being invested in an S&P 500 index is about 10% per year. If you have $1M and you put it all in an S&P 500 ETF, over many years, you will average 10%. But, if you only put $500K into the fund and leave the rest under your mattress, your average return will likely be only 5%/year on your capital (10% on $500K and 0% on the other $500K).
While we want to increase position size and maximize returns, as humans, we often run into psychological issues as position size gets bigger.
In theory, we can tell ourselves risking 1% of a small account is the same as risking 1% of a large account. But on a personal level, is it?
For many people in the Western world, 1% of a $100 account is nothing. They don’t care what happens to the $1 they are risking on the trade. Their mind is at ease, they are not anxious about what happens on the trade. In fact, the risk may not even be high enough for them to pay attention to the trade.
What if you were risking 1% of $500k. Now, you could lose $5k on the trade, or make much more. That’s a month’s pay for many people. That is getting much more interesting. Are you the same calm person? Has your psychology changed at all?
What about if you risk 1% of $1m? Does losing $10k on a single trade make you sweat a little more? Does it matter if it is a trade that lasts 5 minutes or 5 years? The idea of one may be scarier than the other, to you.
Everyone’s “sweat point” is different. It is that point where we go from being calm and relaxed while trading to feeling anxious or stressed because of the size of the position and the potential loss.
If you are used to dealing with big dollar figures in your life, then risking $10k or $50k on a trade may not mean much to you. It’s no different than eating a sandwich.
For others, seeing a trade in the negative -$200, or a -$500 loss on the screen, may be devastating. They may think “Oh my god, that is a huge amount of money!”
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Increase Position Size Slowly Past the Sweat Point
You may not currently know what your sweat point is. Or you may have hit it already and saw your trading performance deteriorate (and maybe you don’t why, until now).
When we hit our sweat point, we become anxious while trading, and when we are anxious the fight-or-flight part of our brain kicks in, and the logical part of our brain becomes less active. Basically, the part of our brain we need to trade shuts down.
When we hit that sweat point and start to feel anxious about how much we are risking, we need to back off. Remember, you will not be able to trade at the same level if you’re highly anxious (some anxiety is normal and fine).
Reduce the position size back to a comfortable level. If you were risking 1% of your growing account balance, you may need to back it off to 0.9% or 0.8%. Or if you were putting $50k into each stock position, maybe you scale it back to $45K or $40K. Scale it back to your comfort point.
You will now be risking less than you ideally should be based on your account size, but that is ok. It’s better than trading in an anxious state and potentially losing money.
Now you know where your sweat point is. This is a natural barrier, based on a few or many beliefs that we have about money. You will need to expand that barrier, very slowly.
Do this by backing off slightly from your barrier. Whatever position size made you feel nervous, back off a bit. Then each week or month (decide on a schedule) increase your position incrementally. Just a tiny bit. If your position size was 100 shares, move up to 105 shares, or if you were putting $5k in a trade, try $5100 or $5200. If you were trading 5 mini lots on a forex trade, slowly move up to 5.1, 5.2, or 5.3.
Take some trades and see how you feel. If all is good, proceed with your next increase at the next time interval. Don’t rush it, otherwise, you will just need to back off again.
As you continue to trade, you will hit many of these barriers. You have the choice to respect the barrier and stay there, or you can do the process and try to slowly expand it.
Some barriers may require internal work to get through, possibly with the help of a psychologist or performance coach.
Final Word on Increasing Position Size the Right Way
Some people seem to have more barriers than others when it comes to money. We were each brought up differently, and have formed different views of money.
Some people will hit barriers almost right away, where the potential of losing even a small amount of money is anxiety-inducing. Respect this, and increase positions slowly, so you maintain comfort and can trade at your best.
Others may not hit a position size barrier at all. They are as comfortable trading $10M as they are with a $5 friendly wager.
As you trade, recognize your emotions. Find ways to deal with them.
Trading without emotion is impossible. Unless you have none, they ARE affecting your life and your #trading.— Cory Mitchell, CMT (@corymitc) January 26, 2022
Instead of ignoring emotions, professional traders identify emotions that affect their trading, then develop ways to manage or redirect them:https://t.co/6tXDHnTcPk
Slowing expanding our barriers is one approach. A more in-depth approach is to examine the beliefs that create the barrier. Beliefs may be based on faulty data that someone told us long ago. We can question those beliefs, and replace them with something more productive.
Another option is to negotiate with the voice that is scared or anxious. The voice that says “Wow, that’s a big position. That’s a lot of money!” or that makes you feel knotted up. If we can negotiate with the voice that is elevating our anxiety, then we may be able to remove the barrier by calming that voice/part of ourselves.
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Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.