An individual trader, regardless of how small a percentage of
net worth is committed to trading,
has to operate on the basis that his or her trading
capital is limited. When capital is limited, the
first focus has to be on risk, with the first
objective survival.
The first step to ensure
survival is to not allocate too much trading capital to any one trade. A
good way to do this is to establish "personal
position limits" for each market (meaning maximum
number of contracts allowed per market). The size of
these personal position limits is dictated
both by the size of the account and the volatility of
a market.
Naturally, every trader
has different acceptable risk levels. A multimillionaire with a $50,000
trading account will
have much different acceptable risk levels on any one trade than someone
whose $50,000 account
represents his entire net worth. Therefore, the following numbers can
be adjusted upward,
somewhat, if you can afford the additional risk. Following is how I would
suggest structuring a
$25,000 (or multiples thereof) trading account.
The markets used in
this example are markets I currently follow and trade. Each trader needs to
set up his or her own
account structure based on his or her market preferences.
The first suggestion is
to break your trading account into groups of "similar" markets
(meaning
markets that tend to be
affected by the same economic factors and so tend to move together).
The point is to prevent
concentrating too much risk in any one group of similar markets.
First divide the account into four separate groups of similar
markets.
For example
1 ~ The Stock Index
group (allocate approximately 30 percent of your account's equity to
this group): Dow,
S&P, and/or NSDQ;
2 ~ The Anti-Dollar
group (allocate about 25 percent of equity): Swiss (and/or Euro), Yen,
Gold, and Silver;
3 ~ The Industrial
& Interest Rate group (about 25 percent of equity): Bonds (and/or Notes,
Eurodollars), Petro
complex (Crude, Heating Oil, Unleaded), Cotton, and Copper;
4 ~ The Food group
(about 20 percent of equity): Corn, Wheat, Bean complex (Beans, Meal
and Bean Oil), Sugar,
and Cocoa.
These subgroup
allocations are approximate. Obviously, if you are faced with excellent
continuation patterns in
the food group and the stock group is very mixed at the moment,
then it is perfectly
acceptable to "borrow" some margin equity from stocks and allocate it
to
foods. However, only go
over these suggested allocation numbers when the technical argument
to do so is very good.
Furthermore, when and if you do temporarily over position in one group,
as soon as the
trend/momentum indicators cease to be exceptionally favorable, go back to your
normal trading levels.
As far as number of
contracts to do in each market, as a basic rule, do not risk more than about
$1000 a day in any one
market (per $25,000 in the account). For example, since the S&P (at this
moment) can easily move
twenty points in a day, you would not want to hold more than one
e-mini S&P for each
$25,000 in your account. However, at the moment, a reasonable one day
move/risk in the Beans
is about ten cents (or $500 a contract), so you could hold up to two
contracts of Beans per
$25,000 of trading capital. Then, when and if normal daily price
movement of a market
changes (i.e., a market becomes more or less volatile), simply change
your personal position
limits accordingly.
NOTE: The larger an account, the lower these
allocations should be—meaning while three contracts
of wheat might be my limit on a $25,000 account, with
a $100,000 account I would consider ten
contracts, rather than twelve, to be more
appropriate.)
The essential point is to keep your positions
"small" enough to avoid any panic-type actions
caused by unexpected adverse short-term price action.
For long-term success it is invariably better
to be positioned "too small" than "too
big." Markets can be volatile and frequently make many
short-lived, "false" moves. When positioned
"small," the cost of waiting for reasonable clarity is
acceptable. When positioned "too big," the
risk of being a little late in acting is so great it tends
to induce actions based on guesses rather than
reality.
As an example, I would consider the following
personal position limits (per market and group)
to be businesslike for a $25,000 account (based on current, i.e., 2002,
volatility).
1 ~ Stock Index group: One contract of either the
"$5 Dow," e-mini S&P, or e-mini NSDQ
per $25,000 (the $5 Dow is the half-size Dow
contract);
2 ~ Anti-dollar group: One Swiss, one Yen, and up to
three contracts of precious metals (any
combination of Gold and Silver adding up to three);
3 ~ Industrial & Interest Rate group: One
contract of either Bonds or 10-year Notes (two
contracts of Notes acceptable if pattern solid), up
to two Eurodollar contracts, one contract
of the "Petro" complex (either Crude,
Heating Oil, or Unleaded), and up to two contracts
of Copper;
4 ~ Food group: Up to three Corn contracts, up to
three Wheat, up to two Beans or any
combination of Meal or Bean Oil up to three
contracts, up to three Sugar, and up to two
Cocoa.
Now let me be clear. I am not implying that you
should hold all of these contracts at the same
time. The point is simply that, from a risk
standpoint, these quantities of contracts per market
are reasonable personal position limits for a $25,000
speculative trading account. Of course, if
the pattern in the Yen happens to be very strong and
the pattern in Swiss mixed, then you could
justify doing up to two Yen per $25K as long as you
did no Swiss. (In other words, it is acceptable
to "borrow" some Swiss risk and assign it
to the Yen when the situation clearly dictates doing so.)
The basic idea is not to commit more than about a
quarter of your account's equity (and
presumably its risk) to any one group of similar
markets (meaning markets that will tend to
move somewhat together).
The numbers mentioned above should be adjusted when
changes in market volatility occur
and/or trend/momentum patterns are unusually strong.
If a market becomes more volatile, then
you should reduce your personal position limits, and
conversely, increase them on decreases in
volatility. Utilizing a general approach like this
will keep your risk exposure in any one market or
group of similar markets under control. In addition,
adhering to these personal position limits will
opportunity to work (i.e., time to respond to the
underlying trend/momentum price energy flows).