Why the professional trader may still beat you?

Apurva Sheth
So you think that by investing equal amounts in all your trades you can match the trading performance of the professional trader?

Think over it again.

It is not as simple as it seems.

In my last article on the importance of Position Sizing I told you how investing equal amount in each trade was a better strategy then randomly allocating money in each trade. But, this strategy again has its own limitations.

For any business to be profitable its revenues should be more than its expenses. The same principle applies while trading. Winning trades are your revenues and losing trades are your expenses. As long as your winning trades earn more money than losing one's, your (Trading) business will be profitable.


Now how do you ensure your winning trades earn more than losing ones?

Well if we knew which trade will be a winning trade we would have invested more money in that trade, right? But the problem is we don't know that.

So we choose to invest equal amounts in each trade. Now the challenge here is to ensure that your winning trades earn more than your losing ones. Like always you are bound to come across some loosing trades despite a good track record.

Investing equal amount in each trade does not necessarily mean that you will lose and gain equally across trades. Your percentage returns on these trades can be something like this, 5%, 6%, 4%, -10% depending on what your stoploss and targets are. So on an equal amount invested across trades you are earning differently. Gaining in some, losing in some.

This creates the problem. What if the trade which goes against you loses more money than the one which is favorable to you? For example you invest 20,000 in two trades one is gaining by 5% and other is losing 6%. So here your expense have overrun your income. And no businessman would want that, right?

Allow me to take a moment more to illustrate this point in detail with an example. The table below is a sample list of trades done on the basis of investing equal amounts in each trade.

Investing Equal Amount in each trade
Stock Buy Price  Stop
loss (%)
Qty Amt. Inv. Sell Price Rs. Earned  Profit / Loss  Max. Loss possible per trade 
A 100 90 -10.0% 10 500 50,000 90 -10 -5,000 -5,000
B 500 480 -4.0% 20 100 50,000 525 25 2,500 -2,000
C 2,000 1,950 -2.5% 50 25 50,000 2,100 100 2,500 -1,250
D 10,000 9,900 -1.0% 100 5 50,000 10,500 500 2,500 -500
            200,000   Net Profit 2,500 -8,750
Stoploss = It is a level at which an investor exits from his original position to limit further loss.
Risk per share = (Buy Price - Stoploss)
Amt. Invested = (Quantity * Buy Price)
Rs. Earned = (Buy Price - Sell Price)
Profit/Loss = (Rs. Earned * Quantity)
Max. Loss possible per trade = (Risk per share * Quantity)

You are investing equal amount of Rs 50,000 across 4 trades. 3 out of these 4 were winners. Each of them delivered a return of 5%. The remaining trade lost 10%. This trade wiped away substantial gains from the other winning trades. This strategy does not consider the risk (stoploss) and the extent of risk (stoploss %) while investing equal amount in each trade. Thus there are wide variations in the maximum loss possible per trade which sometimes gives nightmares to traders.

Despite using a stoploss you may not feel comfortable with the position. At any given point of time more than one live position may be below your entry price. This will make you anxious and nervous. You may repeatedly get the urge to check the quotes during the day. Many a times traders use stoplosses which is a very good thing to do. But they fail to understand the importance of position sizing along with the stoploss. Quite often it would happen that immediately after you have taken a stoploss the price reverses. You feel frustrated and feel like beating yourself up on taking that stoploss. You feel that using a stoploss is a bad idea and refrain from using it altogether. Eventually you get struck by one or a string of losing trades which you don't get out of before it's too late. Now you are staring down an empty barrel of your trading capital which is nearly wiped out and down to zero.

Has this happened to you before?

Now compare this with a strategy which can give you the psychological comfort during a losing trade. How good would that be, isn't it?

This strategy is based on risking a fixed percentage of your capital on each trade. This fix % can be anything from 0.5% to 2%. One can start on the lower end and as one gains confidence in trading one can move higher. Most traders normally stick to the 1% level.

So let's go through an example to understand this.

Total Trading Portfolio Value: Rs 2,00,000

Percentage risk per trade: 0.5%

Step 1: Calculate 0.5% of your portfolio's value:
Rs 2,00,000 * 0.5% = Rs 1,000.
This is your absolute value at risk per trade. You are willing to risk only Rs 1,000 on a single trade and nothing more.

Step 2: Calculate the risk per share of a trade:
Buy price - Stoploss
Rs 100 - Rs 90 = Rs 10.

Step 3: Calculate the number of shares to buy:
Absolute Value at risk per trade/ Risk per share
Rs 1,000 / Rs 10 = 100 shares.

Wasn't that simple. The ideal quantity that you should buy is 100 shares.

Now let me show this with an example.

Investing based on risking a fixed percentage of your capital on each trade
Stock Buy Price Stop
loss (%)
Qty Amt. Inv. Sell Price Rs Earned Profit
/ Loss
Max. Loss possible per trade
A 100 90 -10.0% 10 100 10,000 90 -10 -1,000 -1,000
B 500 480 -4.0% 20 50 25,000 525 25 1,250 -1,000
C 2,000 1,950 -2.5% 50 20 40,000 2,100 100 2,000 -1,000
D 10,000 9,900 -1.0% 100 10 100,000 10,500 500 5,000 -1,000
            175,000   Net Profit 7,250 -4,000

Take note of the farthest column in the above table. The maximum loss possible per trade remains constant despite wide variations in the stoploss. This system allows you to adjust the quantity of shares you buy based on the extent of risk (stoploss %).

Knowing that you will lose only 1% of you capital on any single trade gives you much more psychological comfort than anything else. The biggest advantage is that it will not keep you up at night worrying about where the markets would go. Knowing that no one position can wipe you out of your trading capital is yet another advantage. You get more comfortable taking risk and think of volatility as your friend rather than an enemy.

This technique also adjusts to market volatility. For example, you would keep wider stoplosses when market are volatile which means you will buy lesser quantity. On the other hand, in strongly trending markets you can trade with narrow stoplosses which will allow you to buy more quantity.

For all of its good points, there are some disadvantages as well. You might find your position sizes too small at times, which will lower your overall rate of return. But, smaller positions doesn't mean that your business won't be profitable. It only means that it will just take a little longer to reach upto your goal. But by following this system you are also increasing your chances of winning and staying longer in the game.

After all that is what matters. Staying on.

What kind of position sizing strategies you follow while trading? Share your views in the Club or share your comments here.

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10 Responses to "Why the professional trader may still beat you?"
R Sathyamurthy
29 Jul, 2017
I see few suggestions and questions. I don't see any responses from EM or Apurva Sheth. It will be great if they are also published.Like 
25 Mar, 2015
I have account with interactive brokers who have the option of setting up stop loss and target till it is cancelled as bracket orders which will cancel the other trade if either stop or target is hit which is ideal for this system. The only issue is their initial cash deposit is high. But anyway if you want to trade, you need the money. Like 
Arun Ghosh
10 Mar, 2015
How do you maintain keep stop loss if you are carrying the position for several days particularly when the market opens gap down below your stop loss?.Like (6)
Gopal S Agrawal
10 Feb, 2015
@Vijay Many brokers do provide facility to place orders which are valid for week and even months in equity segement, though I dont know yet for derivative and commodity. It will be good to check this..Like 
09 Feb, 2015
Position sizing has not worked well for me. Particularly in futures. If I want to fix risk amount in rupee term then my strategic stop-loss spoils the spoils the set up. Having fixes lot size hinders position sizing which other other hand possible for cash market. BUT for this I will have to trade intraday only. If my position is in my favor then I can't carry short positions this is alsoa challenge to me. Hence I have a question is the explanation talking about intraday trading only? Like (4)
08 Feb, 2015
It is the correct way to change the quantity based on the risk % Another good way of increasing the profits is to add to winning positions after the price appreciates more than 3% from the entry price. This will also ensure the portfolio appreciates as the exposure will be more on winning positions and we can keep eliminating / reducing positions that is not performing well.Like (1)
yogendra pal singh
08 Feb, 2015
My dear Apurva Seth, I suggest if you take every element Real for your examples it will have better effect. Pick a stock from actual list of Futures and Options .Take their permitted size of lots. Work with existing amounts/rates securities .So exact picture of money involved in risk/loss/profit will come out. I hope it will not be very inconvenient to you.Like 
P S Rao
08 Feb, 2015
I have some questions. Stock with high price (D in above example) has a bright chance to get stop-loss triggered because it is only 1% away. where as the stock A is the farthest from stop-loss. In my view, it should be a fixed percentage risk based on fixed investment amount per trade. What is your view on stop-loss. Should I keep in mind my stop-loss and view prices every few minutes(making my life hell) or should I enter the stop-loss into the trading system and hope that intra-day fluctuations do not FOOL me into closing the trade? What if the stop-loss remains in my mind(if i do not enter into trading system) and fall in stock price is so violent that I lose the appetite to get out at that stage and force me to accumulate more losses?Like (1)
Sameer Khan
07 Feb, 2015
Is it possible to keep overnight and continuous stop losses? How do we do it?Like (3)
vijay srivastava
07 Feb, 2015
Dear Apurva, Thanks for this illustration about Position Sizing, which is ignored by amateurs who just put their hard earned money and hoe that somehow this trade will go in their favor. I believe that our trading mechanism must be so biased in our favour that even if we hit 30% of the times we should win. But I am still not inconvenienced that we can actually manage to have only 1% risk in each and every trade. The only way we can control our stop loss in case of trade going the other way is triggering the stop loss. unfortunately stop loss has to be renewed everyday in case we carry overnight positions. For a working professional like me renewing SL is not always possible though most of the time it can be done with some hiccup. Any suggestion for managing SL for overnight trade would be appreciated. Thanks and regards, Like 
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