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Suppose you have a great system working the market. It’s hitting 90% or better of all its trades and you want to start trading in size. How do you do that without blowing up?
You know what I am talking about. You are on a hot streak. Money is pouring into your account every day and instantly you start projecting linearly. Man -- if I just traded ten times the size, I’d be making $10,000 a week and then after a few months I could double it and start making $20,000 a week and pretty soon I’ll be making a cool million a year off this thing!
We’ve all had that trading reverie when the temporary success in the market seduces us into thinking that we are on the way to fast and easy millions. Needless to say, those daydreams always evaporate. Usually, we over leverage and quickly blow up soon thereafter.
Trading is so hard that we have all sorts of contingency plans for not losing our capital, but few of us think about what we should do when we start winning.
I find myself in that position now. I am running a very successful trend trading strategy that is hitting 90% of its trades and has already managed to bank 10% just this month trading at my maximum lever factor of 4 times equity.
Should I increase my leverage?
I am already flying too close to the sun and frankly, 10% is a ridiculous amount of money to make in just a few weeks if you want to maintain a sustainable model for profit. Those of you who have been reading me for a while know that my motto is 4X 4 Forex -- meaning that no single trade ever should exceed four times the size of your account. I believe this is the absolute maximum amount of leverage you should employ in the markets if you want to survive in the markets for more than a month.
So levering up is out of the question.
Still, I am only using 10% of my capital on this strategy and the prospect of going “all-in” is very tempting. But that would be a huge mistake. Like all high probability strategies, my strategy has a very negative risk reward payoff. If I instantly scale up to ten times my size and hit a string of losers, it would wipe out all the gains of the past few weeks. Mathematically it would have no impact on the overall payout of the strategy because I would still be trading within my leverage limits, however, psychologically such massive loss would be brutal.
In fact, that is how all good strategies die. Greedy traders push them to their size limits, then when they hit an inevitable losing streak the sudden increase in scale erases all the hard earned gains so they quit in disgust leaving possibly years of future gains on the table.
So is there a better way?
I think so. The key as with all things trading is to control your greed and ramp scale up gradually. Instead of plowing all in, I intend to finish out this month with the current 10% allocation. If the strategy performs well I will add another 10% of my capital the next month and so on and so on. This way the scope and scale of capital allocation are manageable. The losses -- both psychologically and financially -- are far more tolerable and more importantly, the ultra slow pace of capital increases will not only help me survive the inevitable drawdowns but will also allow me to intimately study the strategy performance under a variety of market regimes.
It’s great to have a winning strategy for a while, but it’s even better to turn it into a lifetime moneymaker.