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I have a question regarding some “rules of thumb / conventional wisdom” that I’ve seen repeated in a few places.
One piece of the trading puzzle, is using a position size appropriate to account size for the trading method and instrument. The trading method governs a lot (example: scalp vs swing), and so for this case I want to keep it simple. Imagine a trading system that is “all in/all out” with a profit target of 3 ticks and stop loss of 3 ticks.
Taking into consideration two instruments:
ZN – 10 Year T-Note: Contract Size=$100,000, Tick Value=$15.625 per contract
ZB – 30 Year T-Bond: Contract Size=$100,000, Tick Value=$31.25 per contract
As you can see, the per tick value between these two instruments is significant. The bond per tick value is basically double that of the note.
A general rule of thumb I’ve read in multiple places, is that you should have $10,000 dollars for each contract you trade. So, for example if you wanted to trade 2 contracts, you should have $20,000 in your account. I wanted to explore this notion further, because as you can see there is a big difference between trading ZN vs ZB, yet both have the same notional value of 100k.
I read time and again on bmt that undercapitalization is what takes out a lot of traders, they simply don’t have enough money to take the hits while refining their methodology live. So, I’m trying to get more information or math on position size relationship to account size for the instruments ZN & ZB for say a win-3-lose-3 ticks system.
Some will point out, slippage and commissions as factors to consider in addition to the theoretical win3lose3 system, which is true but I'm just more focused with this question being on appropriate capitalization per these contracts.
Would you say that 10k per contract is risky or conservative for such a trading system for ZN? Does the same hold true for ZB, or should one conservatively allocate more than 10k per contract for that instrument?
What to trade and how many contracts/shares to put on are a function of size of account, size of capital exposure per trade (X% of account size) as well as capital exposure total trades on at a time (again X% of).
You mentioned conventional wisdom being $10k/contract. I don't think that precisely accurate. I think conventional wisdom is to trade using the initial and maintenance margin set by the exchange. These numbers are not arbitrary and are set the way they are for a good reason. You should definitely understand the concepts underlying the margin requirements. Very important, actually.
Nevertheless, think about how much you want to trade in terms of how much of the initial margin you are using. $10k/contract is much higher than the initial margin requirement for the ZN and ZB, so yeah it's pretty conservative.
In contrast, the ES has a $11k/ct maintenance margin and NQ has a $16k/ct maintenance margin. Initial margins are, what, 10% higher iirc. So $10k/contract would not be sufficient to hold overnight in those contracts; you couldn't do it if you wanted to. But it'd be perfectly fine (and healthy) for day trading the ES or NQ. 10k/contract would give you a lot of headroom for day trading the stock index contracts.
Bottom line - think of it in terms of how much of the initial margin you're using. If you're using 2 or 3 times the initial margin requirement, then yes it's pretty conservative. Otoh, if you're day trading with 1/20th of the initial margin requirement (which many brokers offer on the index contracts), then that is the exact opposite of conservative; it's dangerous because it doesn't give you many losses before you blow out the account.
How many 3-tick losses will your system give you before you blow out your account when you have $10k per contract in your account. For ZN, a 3 tick loss is about $47; for ZB, it's about $94. Slippage is highly unlikely on these instruments if you're trade just a few contracts. Let's define an account blowout as when your balance is reduced by 50% to $5k. That means you could have about 106 losses in a row on the ZN or53 losses in a row on the ZB...or some combo thereof....before you drew down the account balance from $10k to $5k. So, yeah, that's pretty reasonable because that should be very unlikely. Though I'm not sure how often you trade. If you make a hundred trades in a day, then maybe it's not so conservative. Plus, what is your expected win percentage? Theoretically, for a 3:3 gain:loss, your win percent should be above 50% right? Preferably at least 60% and closer to 70%. If your realized win percent is vastly lower than your expected win percent, then something is broken. For a 1:1 risk:reward ratio (or R value of 1), you really need to be consistently hitting 70% win percent to make it work. Once you drop below 60%, things get very difficult. And below 50% losses you money pretty fast.
Anyway, this is my half baked two cents on a boring trading monday. take it fwiw.
Sidenote, I think CME is coming out with micro treasury yield contracts, just fyi. Might be of interest.
Trading: Primarily Energy but also a little Equities, Fixed Income, Metals and Crypto.
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An analysis I perform is
1/ Calculate X day ATR in points and multiply that by USD/Point size, to get a USD ATR. This gives you an idea of how much the contract moves in USD on an average day
2/ Estimate Slippage per contract in USD add commissions and then divide that by the USD ATR. This gives you an indication of the 'cost to trade'
Don't have the last analysis with me currently (will try to post later) but this shows that things like Silver/SI are cheap to trade and instruments like Eurodollars/GE/ED are expensive to trade. In the Fixed Income space, the cost to trade is directly correlated to rate tenor. So
Most Expensive | Eurodollars >> 2 Year >> 5 Year >> 10 Year >> 30 Year >> Ultra 30 Year ! Least Expensive
