Mine is Small – How About Yours?

by Boris Schlossberg Boris Schlossberg

In trading size matters, but in the exact opposite way that it does in real life.

I am often asked by traders what is the proper leverage -- 100:1? 200:1? And I am always amused by their shocked reactions when I tell them that I trade at 2:1 lever size. That’s right for every $5000 worth of capital, my opening trade size is no more than 10,000 units. Now I may hold 2 or 3 trades at once and perhaps several positions in the same trade, but my OVERALL leverage NEVER, EVER exceeds 10X my equity, In fact, 95% of the time I try to contain my open positions to no more than 5X of my equity at any given time.

That’s a lesson I learned from the school of hard knocks after having burned more accounts than I care to count on lever factors that may seem quaint to most of you (10:1, 20:1).

The single truest fact in trading is that large size kills. There is a reason why FX dealers extend such high leverage to their customers. The law of large numbers assures them that 99% of traders will lose all of their capital due to margin calls.

Keeping the lever factor to just 2:1 on any opening trade will ensure that your account will not blow up due to one badly timed trade, but it will in not you profitable. It could just keep you afloat longer, but you may still drown due to a death by a thousand cuts if you take random, impulsive trades.

My 2:1 lever is actually reserved for my best trade ideas -- the “true” trades -- for those of you who have been reading my columns of late. For everything else -- the let-me-try-this-cause-I-am-bored trades I use a size that is 1/10th my “true” size which for a $5000 account amounts to just 0.01 lots.

Those are not serious trades -- and that’s precisely the point. I found out from my past experience that it is the frivolous trades that suddenly turn deadly serious as you battle for the value of the account. Trading 1/10th size never puts me in that unnecessary situation, while allowing me to blow off steam or try new setups with minimal risk.

So I leave you with this final tidbit of advice. Metatrader defaults its size to 1.00 lot or 100,000 units. If you are not careful, you can point and click and execute a trade size much larger than you intended. To avoid this problem forever go to Tools>Options>Trade Tab and change the default volume to 0.01. You can always increase the size manually later on, but if you do this now -- you will never be subject to that sinking feeling of -- what did I do now?
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Just as in cooking, you can always add salt, but you can’t remove it. In trading, size can always be added but once the trade is done -- you can’t be undone once the button is pushed. So stay small, stay safe and trade well.

Big Profits with Small Accounts?

by Boris Schlossberg Boris Schlossberg

As retail traders of margined products, we all face the same dilemma. We want to make money but realize that leverage will inevitably wipe out our capital in the end.

When I was at FXCM we used to run the “King of the Mini” contests every month. Every month some guy would turn 5,000 bucks into $25,000 and bask in the glory of recognition.

Yet throughout all those years, all those months of contests all those great attempts at making big returns, not one winner ever repeated his feat.

Not.

One.

The reason, of course, is that most of the winners were the classic “have-a-hunch-bet-a-bunch” traders who caught a big move in some highly trending pair and just kept adding to their position. It didn’t hurt that in those days volatility was three times greater and you often saw 500 -- 800 point moves in a month.

Yet even guys who traded systematically could never repeat their winning ways because leverage always tripped them up. Remember that leverage is the true bet in the currency market. Dealers aren’t betting against your analytical skills to read the market or your facility with execution. They don’t have to. They bet that the law of large numbers will always wipe you out through leverage.

Just like dealers in Vegas couldn’t care less about your next roll of the dice or for that matter your next hundred rolls -- all of which you may win -- so too FX dealers could care less about your next trade or your next hundred trades. Both businesses are betting on the asymmetry of the odds in their favor. In Vegas, it’s the closed nature of the games that always makes the house a winner over the long run. That’s why casinos are more than happy to ply you with free drinks and keep you at the tables for as long as they can. The longer you stay at the dealing table, the higher their chances of emptying out your pockets.

Fortunately for us, the markets are not fixed outcome bets with guaranteed payouts to the dealers, but here the dealers are making a very different bet. In levered markets they simply have to bet that you will trade too large just once and that will be enough to wipe out all your prior wins and then some guaranteeing them a profit. And of course, you will. Because no one is 100% accurate ever.

If you trade at 100:1 leverage your chance of survival is 1%. At 400:1 leverage its 25 basis points at best. Put another way your chance of failure at 400:1 leverage is 99.75%. Although this is not really true mathematically, it’s close enough to the actual truth that you should use those numbers as mental shortcuts to assess your chances of success.

So given the crushing nature of leverage is there ever a way to make big money from small accounts?

Maybe.

They say that diversification is the only free lunch on Wall Street so here is an idea.

Diversify both by strategy and product. This Saturday I am teaching a webinar on every BK strategy I ever created. Going back through the strategies in preparation for the show I was shocked to see how many of them were still working well. Their edges weren’t fantastic (on average each strategy was basically banking 200-300 pips a year), but as Senator Dirksen once remarked, “A billion here, a billion there and pretty soon you are talking real money.”

So idea one is to create a separate brokerage account for each strategy. But don’t stop there. Create a separate account for each FX pair per each strategy so that you can sandbox risk as much as possible.

We know that in FX the same strategies could have wildly different results on different pairs. What works on GBPUSD may not work on AUDUSD and crosses are a whole separate issue altogether. So to protect yourself from the idiosyncratic risk of one bad trade blowing up your whole account here is the full idea.

Say you have $10,000 or risk capital. DON’T put it in one account. Create 10 separate trading accounts of $1,000 each. Say you have 3 good strategies to trade. Trade one strategy and one pair per account. So, account 1 has Strategy 1 EURUSD, account 2 has Strategy 2 EURUSD so on and so forth. At the end, you have 9 accounts that are trading 3 strategies on EURUSD GBPUSD and USDJPY the last account is just a cash reserve account. You trade your ideas on 10:1 maximum leverage (because that is the maximum I believe you can ever get away with).

Here is what will happen. One of your accounts WILL BLOW UP. But that’s a good thing. All the damage will be isolated to just that $1000.00 of capital. This is really good news both financially and psychologically. The broker’s margin call software will instantly liquidate you, effectively providing the stop that you are either mentally unwilling or technologically unable to take yourself.

But there is a much bigger psychological value to creating this structure. Every single blow up I’ve seen starts with a refusal to recognize a loss. The more money you have in the account the easier it is to let the loss float and fester like an infected wound until amputation is basically your only choice. Segregating your funds this way makes it much easier to get rid of bad trades. Physiologically blowing up a $1000 account is much easier than taking a $1000 loss in a $10,000 account -- and since you have no say in the matter anyway -- the hard decision is made for you. In the meantime, the accounts that are working could be doubling your money in year’s time -- turning you into The King of the Mini.