Wednesday, April 30, 2014

Diversification with Meaningful Position Sizing

The blog tischendorf letter has some sensible ideas on trading appropriate volume (position size). While all of us warn traders on overtrading and on carrying large positions which they cannot afford, the reverse is also true. I am quoting from the blog:

Ed Seykota says: ‘Risk no more than you can afford to lose and also risk enough so that a win is meaningful.’ My experience tells me lots of traders have difficulties applying this rule because they probably don’t fully understand the implications.

It is obvious you shouldn’t put all your eggs in one basket unless you are watching the basket very closely. Personally I like to diversify a bit but as a general rule I pay attention not to diversify too much and I keep my position sizes meaningful. The reasons why I do this are the following:

--> You don’t lose focus.
--> Fewer positions force you to be disciplined and do your DD (due diligence)
--> You are forced to focus on the best technical setups.
--> No excuses. If there are two stocks you could choose from go with the better one.

Sticking to fewer stocks and spending more time on the selection process will increase your discipline and your focus. That alone is worth it as you are more likely to reach a ‘flow state’ where you only trade the best stocks with the best setups offering the best odds. Then you are able to trade at peak performance.

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