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Follow these two rules to preserve and grow capital

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Follow these two rules to preserve and grow capital

Based on my own experience and failings, I've formally adopted two rules:

  1. Never add to a loser, EVER. EVER. If adding to a winner, close the position if the market moves to your average entry price (your breakeven point), and only add above (if long, below if short) your previous add.
  2. Don't take more than 3 losing trades in a 15 minute period, and 10 trades in a 2 hour period (adding to a winner doesn't count as a trade; a 1 tick or greater loss does count).
Rule 1 prevents death by nuclear explosion.
Rule 2 prevents death by a thousand cuts.

The premise behind these two rules:
  1. Rule 1: If you add to a loser, you're throwing money at an idea which has, thus far, not worked. Make the market prove to you that your idea is working. Otherwise, you run the risk wanting the trade to work (which you never should want; instead, you want total objectivity with no particular bias towards the long or short side) and losing your objectivity.
  2. Rule 2: If you take this many trades, even if they are tiny losses, chances are that you are not in tune with the market, and are likely in fear of missing some move you think is coming.
When you're wrong, rule #1 makes it impossible to be "more wrong," so you can only be "wrong small"; it also promotes being "right big."
When you're wrong, rule #2 makes it impossible to accumulate many small losses due to taking too many impulsive trades in an attempt to not "miss the move" and promotes a patient attitude.

I'm not really a big fan of rules surrounding which trades to take, and when to exit those trades, as my approach to markets isn't too quantitative. But when it comes to position and risk management, the above 2 rules are really a must for me.

By following the rules above, the follow gut-wrenching scenarios are prevented:
  • You try to buy every dip in a falling market, and you're down 100 ticks as it bottoms; however, you realize that it's only down 60 ticks from where you initially bought; through a combination of adding and overtrading, you have lost twice as much as you would have lost by simply buying one and holding it. Or worse, you've only added and are now massively long at the lows.
  • You try to catch a breakout but chop yourself up in a range of consolidation; you lose 40 ticks while it consolidates because you keep jumping in and out, losing a tick here and there, and realize that you now need a pretty big move from the breakout just to get back to even. Worse, upon realizing this, you then add size, the breakout fails, and you wind up losing even more.
Chime in with your own risk management rules if you like, or feel free to discuss these.


Last edited by josh; March 3rd, 2018 at 01:38 PM.
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