We'll start our discussion in this module about trade adjustments first explaining the #1 adjustment that you can make to every trade that you enter right now. And while unconventional at first, we'll hopefully build the case as to why this one adjustment can be the difference between making and losing money at the end of each year. It's important to also recognize that adjustments are a way to reduce risk first and increase your profit second. Many people go into an adjustment hoping to make more money when in fact they should be concerned about reducing risk.
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In this video tutorial, I want to go over the number one adjustment that you can make for any trade that you make in the future.
Far too often, traders are focusing on the wrong things when it comes to making adjustments. You know we’re fans of letting the numbers work themselves out as we say a bunch of times in video tutorials and blog posts and guides that we have at Option Alpha.
The reason we can have the confidence to say this and let the numbers work themselves out is that we do this one thing for each trade that we make and you should do it too, and this one thing is that you have to keep your position sizes small.
It sounds so trivial, you hear this all the time, but it's so, so vital and that’s why this video and this topic is the first thing that we cover in this section about adjustments.
If you do this, you can afford to let the numbers work themselves out over time because a handful of losing trades here or there won’t kill you because they’re going to be small trades.
But many people always believe that with a small account, “you need to trade larger positions to make up lost ground that you have in commissions and time.” I hear this all the time, and I see it with students that I’ve coached over the last eight years.
They come to me, and they have this small account size, and they say, “Kirk, that doesn't work for me.” The “Yeah, but…” crap comes in. “Yeah, but I can’t do that because I have a small account. Yeah, but I can’t do that because my commissions are too high.”
What we want to do is let you know through this tutorial and this case study that we’re about to present that that couldn't be further from the truth.
This case study is going to prove 100% why smaller positions are more profitable regardless of the win rate which is so important. The guys over at Tasty Trade did this study, and we’ll link to this in the video below and the notes on the page.
This is not our study that we did, but it is a great study that proves the point here of why you have to trade small. What they did has they had two traders that made the same trades, and they mimicked these trades over the course.
I believe it was four years or five years, it might have been almost five years, but same trades for both of the traders. The only thing that they did differently is that Trader A traded each position with 5% of their account balance.
They started with $10,000, so it’s a very average account size in the industry. Most people who open up an account open it up with about $10,000. Trader B traded every single position with $50,000.
As you see right here in the middle, the number of wins in both cases for Trader A and Trader B (because they’re making the same trades) was 74%.
Almost 3 out of 4 trades that they made were wins, and you would think the person who is trading more of their account balance would end up with the bigger return at the end of the year, but that just wasn't the case.
You can see the same win rate in both scenarios. It was Trader A who traded a smaller portion of his account that ended up winning and Trader B who was just over allocated but made the same trades with the same win rate lost almost half of their account balance.
You can see that account balance and trade size has everything to do with your ability to be successful in this business. You have to stay small, so that those big trades that go against you, those black swan events or those long tail risk events that happen which of course will happen as you start making more trades over the next couple of years.
They don't eat up and blow up your account, and that’s the key here. If you want a quick guide on how to use proper position sizing, be sure to check out our free tutorial and PDF inside the membership area. You can download it.
It’s a great quick grid that you can use to determine proper position sizing for your portfolio and account size. As always, if you guys have any comments or questions, please add them right below this video. Until next time, happy trading!