“In trading, there are times when you should take positions so big they make you feel uncomfortable.” as said by the author of Alpha Trader and a must-follow on Twitter, @donnelly_brent, in October of 2022.
But not out of control.
In order to win, you need to be a quick driver. But not so quickly that you crash into something.
When trading, do you tend to go large or small?
The topic itself is intriguing, and I think it contains an important assumption that many people will fail to see. Do you make trades on a whim, or do you follow a set strategy? If the former, then Brent is correct; if the latter, I would argue the contrary.
Traders with discretion engage in narrative trading. That story is usually fundamental, but it could also be technical.
The argument is that they are trading a very specific story, and that their position sizing should reflect the degree to which they believe in that story.
Have a quick look at this basic introduction into lot size in trading. Very helpful.
George Soros, the greatest trader of all time, once said, “”It’s not whether you’re right or wrong, but how much money you earn when you’re right and how much money you lose when you’re wrong.”
Of course, Soros was wrong rather often; his greatest skill was in betting big when he was correct.
The British Pound trade, in which Soros made a billion dollars (back when a billion really meant something) in a couple of weeks, is the paradigmatic illustration of this strategy in action.
Soros was the master of the probative trade; he would repeatedly prod the market to test his hypothesis, and then, if the price moved in his favor, he would aggressively pursue the transaction.
Soros’s fund risked the entire year’s earnings on a single position in the pound struggle against the Bank of England and became a trading legend as a result.
But if you trade like I do—systematically—the Soros way is almost certainly the quickest way to bankruptcy. This is due to the fact that systematic trading pursues a distinctive advantage.
Instead than being motivated by stories, systematic traders pay attention to how the market actually acts.
The notion is that a systematic method can carve out a positive stream of profits if correct stops and targets are wrapped around the trade, since certain sorts of patterns are so repeated and predictable.
I focus on one main systematic principle when trading, which is that price tends to turn around from session highs and lows.
Of course, there’s a lot more to it than that, but the core idea is that if you set up your auction correctly, you can take advantage of the fact that mean reversion is much more prevalent than continuity in auction-based markets.
My setup is traded with a 1:1 risk reward ratio, giving me a positive edge if I’m just 51% correct.
Systematic trades are like mass-produced donuts; they always taste the same, but discretionary trades vary in quality from day to day. Thus, methodical tactics of consistent size in trading are highly recommended.
It is easier to absorb inventory losses (your equity drawdown) and make appropriate adjustments when your inventory losses are relatively modest, so I would argue that trading smaller rather than bigger is always an advantage with systematic trading.
This is because the donut batch can often become spoiled (probabilities change in different regimes).
A systematic method is dependent on the law of large numbers, which dictates that a small sample size is necessary to detect a marginal advantage.
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Citadel, led by Ken Griffin, trades 100 shares of stock a billion times a day for a tenth of a penny and a 51% win rate, yet still generates annual revenues in the billions.
But that pales in comparison to what Soros made with a single successful billion-dollar macro gamble.
In their pursuit of profits, retail traders frequently make the fatal error of trading systematic concepts with a discretionary size, despite the fact that they typically lack the knowledge to do so.
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