Investors can easily lose sleep over a position that goes the wrong way. Maybe the Dow Average cratered by 700 points, Gold was down $50, the Euro was spiking 2 cents, or oil was making one of its periodic $2 moves.
What’s the answer? Cut your position in half. If your position is so large that it won’t let you sleep at night on the bad days, then you have bitten off more than you can chew.
If you still can’t sleep, then cut it in half again.
The endlessly recurring question is: What is the right size for a single position? Spoiler alert! The answer is different for everyone.
After trading this market for nearly half a century, I have done a lot of research and taken a lot of risks my entire life — financial and otherwise. So my taking a risk is not the same as someone else taking a risk.
Taking risks is like drinking a fine Kentucky sipping Bourbon. The more frequently you drink, the more you have to imbibe to get a good buzz. Eventually you have to quit and start the cycle all over again. Otherwise, you become an alcoholic.
It is best to start out small when taking on your first positions. Imagine if the first time you went out to drink with your college dorm roommates, you finished off an entire bottle of Ripple or Thunderbird? The results would be disastrous and nauseous, as they were for me.
You may be new to investing, new to trading, and find all of this money stuff scary. Or you may be wary, entrusting your hard-earned money to advice from a newsletter you found on the Internet!
What if my wife finds out I’m doing this with our money? YIKES! That is totally understandable, given that 99% of the newsletters out there are all fake, written by fresh-faced kids just out of college with degrees in Creative Writing, but without a scintilla of experience in the financial markets.
I constantly hear of new subscribers who are now on their 10th$4,000 a year subscription, and this is the first one with which they have actually made money.
So, it is totally understandable that you proceed with caution.
I always tell new readers to start out paper trading. Virtually all online brokers now have these wonderful paper-trading facilities where you can practice the art with pretend money.
Don’t know how to use it? They also offer endless hours of free tutorials on how to use their platform. These are great. After all, they want to get you into the market, trading, and paying commission as soon as possible.
You can put up any conceivable strategy, and they will elegantly chart out the potential profit and loss. Whenever you hit the wrong button, and your money all goes “poof” and disappears, you just hit the reset button and start all over again.
No harm, no foul.
After you have run up a string of two or three consecutive winners, it’s now time to try the real thing. But start with only one single options contract, or a few shares of stock, or an ETF. If you completely blow up, you will only be out a few hundred dollars.
Again, it’s not the end of the world.
Let’s say you hit a few singles with the onesies. It’s now time to ramp up. Trade 2, 3, 4, 5, 10, 50, or 100 contracts. Pretty soon, you’ll be one of the BSDs of the marketplace. Then you’ll notice that your broker starts following your trades since you always seem to be right. That is the story of my life.
This doesn’t mean that you will enjoy trading nirvana for the rest of your life. You could hit a bad patch, get stopped out of several positions in a row and lose money. Or you could get bitten by a black swan (it hurts!).
You can shrink back to trading one contract, or quit trading altogether. Use the free time to analyze your mistakes, rethink your assumptions, and figure out where you went wrong. Was I complacent? Was I greedy? Did hubris strike again? Having a 100% cash position can suddenly lift the fog of war and be a refreshingly clarifying experience.
We all get complacent and greedy. To err is human.
Then reenter the fray once you feel comfortable again. Start out with a soft pitch. Over time this will become second nature. You will know automatically when to increase and decrease your size.