Why Trade Size Matters

Comparing yourself to others is a very human trait…

Rightly or wrongly, most of us benchmark our achievements to someone else’s.

I know a thing or two about this subject — it’s something I’ve done many times. First in the schoolyard, then later in the workplace. There’s always been a comparison to make.

You see, comparisons are a source of feedback. They can help you peg your progress against someone else’s. When done constructively, they can provide motivation and knowhow to do better.

But not all comparisons are useful…and some can be downright dangerous.

A mistake I’ve made was to use a peer’s career as yardstick for my own success. Rather than propel me to greater heights, this self-evaluation could have left my career in ruins.

The problem in this instance was imperfect information. I could only see the situation from the surface. There was no way to know what lay beneath.

You may recall a recent update on the topic of risk. I told you how trade size — and the number of stocks in your portfolio — can affect performance. You can refresh your memory here.

I’m going to reinforce this today with a story. You’ll see why controlling risk is so important. It will also show you why benchmarking yourself against someone else isn’t always wise.

So let’s begin…

A parallel universe
My archrival during my 20s was a guy we called Axe. Everything he did was full on. He was a ‘crash through or crash’ type of guy. Nothing Axe did was by halves.

I met Axe during my university days. We were both studying economics; Axe was at the University of NSW, whereas I was at Sydney Uni. But that wasn’t all we had in common.

Axe and I were both runners — although he was a little bit faster.

We also drove the same make of car. I had a 1960s MGB, while Axe had a rarer 1950s MGA.

Even our jobs after graduation were similar. I was a trader at Bankers Trust. Axe had practically the same role at a rival Wall Street titan. Our worlds were seemingly in lockstep.

I remember a conversation with Axe in the mid-1990s. It was about the pending release of US employment data. This was a market-moving event. The right trades could make you a lot of money.

Axe and I were both trading interest rate futures. And we had the same view about where the market was heading. Our trade plans were almost identical.

There was just one difference — our trade size. Axe’s position was 10 times larger.

I felt like a small player. Axe and I began our careers at the same time. But he was now trading much bigger volumes. It made me question myself as a trader.

I went back to my desk and did some calculations. Surely there was a way to build a bigger stake.

But do you know what? There wasn’t.

No matter how I did the sums, I couldn’t justify a bigger trade. Axe stood to lose hundreds of thousands of dollars if he was wrong. This was a risk I simply couldn’t take.

In the end, we both made money on the trade — although Axe made a lot more.

This event stuck in my mind. I began to think about modelling myself on Axe. Perhaps I had to grit my teeth and trade bigger. Maybe I was just being overly cautious.

‘House of Cards’ Trading
Axe got us all together a few months later. He had some news — a major promotion. His string of big wins had landed him a job on the bank’s New York trading desk.

But trouble was brewing…

It turns out Axe was using a high-risk method to set his trade size. It was like a parlay system — a betting strategy that rolls all the winnings from a past trade into the next.

This type of strategy can quickly turn a small stake into a fortune. The problem is that you need to keep winning. I now understood how Axe was trading such big positions.

Axe could do no wrong for years — he rode a long wave of mostly good trades.

But then, within 18 months of reaching the Big Apple, it all began to unravel.

A series of bad trades set the ball in motion. What should have been a rough patch quickly became a rout. Axe’s excessive risk-taking was now a lead weight around his career.

With losses snowballing, management didn’t hesitate to cut their losses. Axe was soon on a one-way flight home. His winning streak was over.

But that wasn’t the end.

Axe still had a good local reputation. He quickly got a trading role at a large Australian bank. It was business as usual. Axe was trading as if his recent meltdown didn’t happen.

History was quick to repeat. It was all over in months. I’m told Axe’s losses were so large that the dealing room lost much of its bonus pool that year. He was not a popular guy.

Axe and I had many similarities. He was a slightly different version of me — and, for a time, a seemingly more successful version. I guess that’s why I’d compare myself to him.

But there was one key difference: I was more conservative with risk. This single variation would ultimately lead to completely different outcomes.

I last heard that Axe was a labourer in central Queensland. The stress of taking on too much risk finally broke him — mentally and financially.

Risk has a way of catching up with people. It can extinguish even the brightest of stars.

So how should you decide your trade size?

Well, I’m going to save the answer for next week. There’s too much to talk about in the time remaining. But I will say this: I think you’ll find the chart I have in store for you fascinating.

Until next week,

Jason McIntosh,
Editor, Quant Trader

Editor’s Note: Jason believes stocks are shifting dramatically higher. He bases this on three little-known indicators. You now have a rare window to step inside…and set in place a series of trades to ‘front-run’ a potentially monumental surge in ASX stocks. I’m talking about the kind of surge that — if you have the right trades in place — could turn a $12.5k starting account into over $250,000…Click here to read about this unusual opportunity.

PS: All charts are sourced by Quant Trader unless otherwise stated.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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