Sizing & how to manage risk

3 ene 2023

The easiest part, if everything's perfect you just trade as much as the market allows before the diminishing returns hit hard. However usually everything is not perfect at the beginning, so continue reading.

Logically, in order to operate successfully & continuously (you can't market make much you if loose money aye?), your equity chart should represent a smooth movement from down left to the top right corner. What factors affect an equity chart?
1) Market activity itself;
2) An operation principle (strategy/system);
3) An operator(s).

So our potential sizing formula/algorithm should, lol, contain these 3 factors. Makes sense?
1) If market activity is too narrow we increase size, if market activity is too wide we decrease size, otherwise if its normal we don't change anything;
2) After a systemic loss we decrease size, after a systemic profit we increase size, otherwise after a +- breakeven we don't change anything;
3) If there's real confidence about what's coming you increase size, if there are doubts you decrease size, otherwise you don't change anything.

Number 3 needs a lil clarification, I didn't say "you're confident/have doubts", I said "there's confidence & there are doubts". It's not only you and quality of your operation, what you also need to feel is whether all of us, as the collective, whether the market itself is confident. And there you can use all the available info, all the other assets, all the non-market data. Understand that we are all the market, you're part of it when you trade. Every1 looks at the same data. The Collective. The Feedback loop.

Ok, so how to increase/decrease exactly?

First you need to calculate the maximum size.
1) Come up with the maximum tolerated loss in money for one trade (more on that later);
2) Look at the chart and find the maximum distance between the entry & exit-at-loss points;
3) Find out the maximum size that won't allow you to loose more than max tolerated loss in case of passing the distance you've just found out.
These numbers should be reevaluated when there's a change. Don't forget that a change can be seasonal, just like volatility on ES futures changes after US open.

Imagine you ended up with 70 lots. Divide it by 7 equal chunks. Why 7? Because of number of factors, we had three, 3*2 + 1.
So now one chunk is 10 lots. One decrease/increase = 10 lots.

Then you start trading at 4 chunks (40 lots) (3 + 1) (this way you got more freedom, you can both increase and decrease after the first trade).
Then you just and increase/decrease according to the plan. For example, you made a profitable trade at 4 chunks, and the next level is very tight, so you have 2 systemic increases, so you increase by 2 chunks (20 lots).
If you hit zero chunks you make a imaginary trades and then come back to the real account when your size becomes one chunk, if you hit 7 chunks you don't go higher (maybe couple of 8 chunks trades might make sense tho).

You're free to fine tune this adjustments live, you can eg see a serious vola increase and decide to decrease by 13-16 contracts instead of 10. Calculating these things precisely won't magically turn a loosing operation into a profitable one, but will make you focus on the wrong thing & steal your energy. Don't calculate, trust yourself & let your brain approximate and feel da thing.

Let's come back to the maximum tolerated loss in money. Making it 1% or 2% or 37565476% of deposit doesn't make any sense.
First of all, a deposit can be financed externally, with a credit line, with a prop shop etc. You deposit should never be touched, only the risk capital above this deposit.
Second, what you care about 4 real is how much risk capital do you have. For example let's say 10k, that's actually a good amount of money.
Third you divide the risk capital by 7, and end up with max tolerated loss in money for one trade. No, consecutive loss streaks have nothing to do with coins & binomial distributions, so number 7 is not worse, but better cuz it's simpler. I think 4-5 consecutive losses are "OK", but 10 is too many.

P.S.: if you've lost you risk capital/thing ain't going, you just stop, evaluate, fix the problems, test on simulator & start fixing another risk capital, and go again, until the victory!