A new trader I know was lamenting about a futures trading system he was interested in trading. “I like it a lot,” he said, “but it holds trades overnight. That means I can only trade half as many contracts, because of the exchange margin requirements. I am trying to trade as many contracts as I can, and I like the lower day trade margins.”
I’m sure some of you are reading this nodding your heads in agreement. Is this sort of position sizing a problem? It sure is.
Let me put this bluntly: If you position size based on minimum margin requirements (i.e., maximize the amount of contracts or lots to trade) in ANY futures or forex market, eventually you most likely will lose all your money, because you are overtrading. Your risk of ruin becomes huge when you overtrade or overleverage.
How do I know this? 1) I’ve blown out accounts doing this myself, and 2) margin requirements are determined by the exchanges, which have nothing to do with your particular trading method. How can you base your position size on a number (margin required) which knows nothing about your particular potential losses and drawdowns?
So, how should you position size? There are numerous position sizing methods out there, and many good books on the topic. The key is your position sizing should reflect your tolerance for risk and reward, and should incorporate characteristics of your particular system. For example, if you knew your tolerance for maximum drawdown was 50%, you could take that requirement, combine it with your system’s trade history, and run a Monte Carlo analysis to determine the appropriate position sizing technique.
One key to survival I’ve found over the years is not to overtrade. Trying to maximize the position size based on minimum margin requirements is definitely overtrading.
