Ep. 1375: Size It Right with Michael Covel on Trend Following Radio

Please enjoy my monologue Size It Right with Michael Covel on Trend Following Radio. This episode may also include great outside guests from my archive. --- I'm MICHAEL COVEL, the host of TREND FOLLOWING RADIO, and I'm proud to have delivered 10+ million podcast listens since 2012. Investments, economics, psychology, politics, decision-making, human behavior, entrepreneurship and trend following are all passionately explored and debated on my show. To start? I'd like to give you a great piece of advice you can use in your life and trading journey… cut your losses! You will find much more about that philosophy here: https://www.trendfollowing.com/trend/ You can watch a free video here: https://www.trendfollowing.com/video/ Can't get enough of this episode? You can choose from my thousand plus episodes here: https://www.trendfollowing.com/podcast My social media platforms: Twitter: @covel https://twitter.com/covel Facebook: @trendfollowing https://www.facebook.com/trendfollowing/ LinkedIn: @covel https://linkedin.com/in/covel/ Instagram: @mikecovel https://www.instagram.com/mikecovel/ Hope you enjoy my never-ending podcast conversation!

• 0:00Speaker 00

  Many times when I've done events, big audience out there, and I'll ask for a show of hands. I'll say, what is the percentage of your limited capital that you should bet on each trade? 1%, 2%, 5%? I have gotten in situations before where the hand goes up at 10%. Talk about not having any idea of math at all. You could probably take a 4th grade kid with decent intelligence, without understanding anything about trading, or betting, or gambling, or anything, and get them to understand, in a game where you have a very minimal edge,

• 0:41Speaker 00

  that betting 10% per time, per trade, would be a disaster. The sure path to risk of ruin. It's not your setup, it's not your indicator, it's not your information, it's not your insight. Whatever your insight is, hopefully it's trend following, it's how much you bet. That's it. But you know what bet sizing, as they call it, or risk management, as they call it? Kind of feels like, I don't know what's gonna happen next. Think about how many people can't handle that sentence. "I don't know what's gonna happen next." So since I don't know what's gonna happen next, I will believe anybody that sounds confident with some type of bullshit narrative,

• 1:26Speaker 00

  as long as they're standing in front of a red Ferrari or an orange Lamborghini. The expensive car that sells me. In a day and age when AI can make anything, give me a picture of somebody who probably isn't even real anymore. Give me a picture of a fake person in front of a fake car, telling me that I can make the fake money like they did through day trading, through, I don't know, buying and holding crypto. Wild world, huh? So what happens? Yeah, most people just say, "I don't want to talk about that, I don't want to think about that." When do I enter? When do I buy, Mike? Just tell me when to buy.

• 2:11Speaker 00

  And think about how crazy that is. That someone actually thinks I can tell them when to buy with some perfect foresight, some perfect moment for them to buy. And in their IQ deficient mindset, they don't ponder for a moment that if they ask that question of someone like me, why are they not asking about the exit at the same time? Like, when do I buy? When do I exit? At least that's better, right? At least we are starting to get into a trend following mindset with that level of awareness. But why does it work this way? Why does entry, the buying point, get all the attention? I bought here because, well, bet sizing, position sizing, risk management doesn't tell you a story.

• 2:55Speaker 00

  It doesn't sing sweet nothings into your ear. It doesn't give you a kiss on the forehead every night. Position sizing says, I don't know if this will work. I don't know how long the drawdown might last. I don't know how ugly this could get. Markets don't reward certainty. You're not certain, I'm not certain. Where do I get in? How long can I stay in? They assume they'll adapt. They assume they'll stop if it gets bad. No plan. Well, casinos don't care if you win tonight because they know you're probably going to lose tomorrow. This distinction explains almost every trading failure you've ever seen or heard about. Let's talk about history because history is unforgiving on this point. Long-term capital management, they are the poster child.

• 3:40Speaker 00

  Great books on them, great films. They didn't blow up because their trades were insane. Nick Leeson didn't destroy Baring's Bank with one bad trade. Amherst didn't die because natural gas is, quote, unpredictable. All those situations are just about risk management. They're about bet size. They're really about greed. Because, look, if people just say, I'll just get out, I'll just stop out, they're lying to themselves. They don't have a plan. They think they're going to have the emotional cojones to do it, the exit, when they're supposed to. But they really don't even have a plan. There is no exit when they're supposed to. Let me make it painfully concrete. Trader B didn't lose because the system failed. I understand this market. This time is different.

• 4:25Speaker 00

  My model accounts for this. No, markets don't care about that crap. The only question is whether you're still standing when it does matter. This comes down to controlling exposure. Can you control your exposure to that certainty that doesn't exist? Can you control your exposure to uncertainty? If you think about it, betting 1% or 2% per trade, and people start to think, "How could I make money that way?" Well, you're not going to get rich overnight. You know that, right? It's going to take some time. I mean, I beat this dead horse continually.

• 5:04Speaker 00

  But the great lesson in trend following is to look at those people that have come before us. What are their track records? What is their evidence? How have they done? And when you get into that thinking, and you go down that path, and you're thinking about a particular style or strategy, there's very few strategies where you can see their evidence of performance. I mean, I have old documents from, I don't know what they were, Barclays, something like that. Old newsletter documents from the 70s and 80s. Don Cian's firm, early Don, early Henry. Often when these guys were managing like hundreds of thousands of dollars,

• 5:46Speaker 00

  if not a few million, like a blip on the radar at a Wall Street, nothing. But you can go back and you can see the performance. And it does give you conviction that there is something to this. The something to it is the arithmetic. It's the math. It's the counting. Back to my entries. Ed Secoda didn't talk about entries first. That wasn't what he did. If sizing matters more than entry, which it does, why do professionals struggle to apply it consistently? And why does the math that explains it, why does that cause so many people to go haywire? I mean, we're in a situation where... We all know, because we can generally all read,

• 6:29Speaker 00

  and reading is different than understanding, that's for sure. But the numbers of people who refuse, or just don't go into any type of risk management, or bet sizing, or position sizing to run their life. Did you hear about the NFL football player recently? Odell Beckham made like 100 million bucks in professional football. And he starts talking about how it wasn't a lot of money. Now, there's documentary films about this, that most professional NFL and NBA players go broke, regardless of how much money they make. But he started saying, well, you know, if you make 100 million, you know, 40 million goes to Uncle Sam. It's a lot more than 40 million. It's probably like 60 million. Then you gotta buy your mom a house. You gotta buy your friends a house. And I mean, that's a really pedestrian

• 7:14Speaker 00

  form of understanding position sizing and risk management. But it's still kind of the same. If you blow out, if you bet at all, and you lose all your chips, you can't play anymore. So it does come down to, like always, the six inches between the ears. It's psychological. But let's be frank, a lot of people don't use bet sizing or position sizing just because they don't understand it. Entry lets you pretend you're in control, but bet sizing forces you to admit that you're not. Remember, bet sizing says something quite clearly. I don't know how this will play out. I don't know how long the drawdown might last. I don't know how ugly the path could be. But people push all their energy into that moment of entry

• 7:57Speaker 00

  because that's where the ego gets you. The ego gets you excited. I mean, here's another way to think about it. You can post your entries. You can explain your entries. You can try to defend your entries. You can't post about good bet sizing, good position sizing. No one praises the trade you didn't overtrade. And let's be frank, since markets don't give feedback on sizing immediately, people mistake silence for irrelevance. That's a fatal error. Entry is the beginning of the trade. Sizing is the beginning of survival. Entry answers the question, where do I get in? Sizing answers the question, what happens if I'm wrong longer than I expect?

• 8:40Speaker 00

  I mean, back to the simple reason, why do smart people go broke? It's not because of bad ideas, not lack of discipline, not ignorance. Usually, it's size.

• 8:49Speaker 00

  Smart people tend to believe their understanding justifies larger bets. They confuse comprehension with certainty. They say things like, "I understand this market. I've studied this deeply. I know why this should work," but markets don't care about that. Markets care about how much exposure you have when the variance shows up. And the variance, the volatility, always shows up. That is where the Vegas casino analogy becomes unavoidable. Casinos don't optimize for winning streaks. They optimize for survival across infinite trials. They know some of you out there are going to get lucky. They know some nights will be bad. They don't change the rules because of one outcome. They

• 9:33Speaker 00

  manage risk first. You manage excitement. Most traders behave like players. They size up after wins. They size up on confidence. They size up on conviction. They treat recent successes as proof. Professionals treat recent success as a warning because success increases the temptation to oversize. Let's be frank. Sizing is the strategy. Everything else is commentary. Two traders can trade the same rules. Same entries, same exits, same markets. One survives. One dies. Not necessarily because one is smarter, but because one respected

• 10:17Speaker 00

  exposure. Kelly criteria, you've heard about it. It's not a magic formula. It's not a commandment. It's a lens for understanding the relationship between edge, variance, and ruin. Kelly answers one question. Given an edge, how much can you bet to maximize long-term growth without guaranteeing ruin? That's it. Kelly does not ask how confident you feel. Kelly does not care how good your story sounds. Only three things: probability, payoff, variance, emotion, irrelevant. That's what makes Kelly, your understanding of risk, ruin, your bet sizing foundation,

• 11:02Speaker 00

  so uncomfortable, takes ego out of the question. This insight behind the Kelly criterion, if you've not read the paper, it's a little bit mathematical, it's a little foundational to trend following, but the insight is simple and brutal. Bet too little and you waste opportunity. Bet too much and you guarantee you're ruined. What does that leave us? A narrow range in between where growth is maximized. But let's be honest, if you know something about this, full Kelly is untradeable for humans. Yes, in theory, it maximizes growth. In reality, it might be too steep a drawdown for humans. So full Kelly, psychological torture, man.

• 11:43Speaker 00

  And that's the real danger, leading to, you know, strategy abandonment, emotional overrides, and changing your size at the worst possible moment. Professionals, fractional Kelly, half Kelly, quarter Kelly, sometimes much less. The goal is not necessarily maximum growth. The goal is always survival with some freaking sanity. But people don't necessarily oversize because they are only reckless. A lot of it, just being a human. Big recent win, confidence goes up. People think a streak is skill, where they want results now. Uh oh, it's FOMO, fear of missing out. They want to feel committed.

• 12:27Speaker 00

  Oversizing is emotional leverage. It feels like saying, I believe in this. Ladies and gentlemen, markets punish belief. They reward resilience. They reward survival. And that brings me to the cruel math of ruin. The math no one really likes to calculate because once you see it, you can't unsee it. A 50% loss requires a 100% gain to recover. 70% loss, 230% gain to recover. A 90% loss? You might just be living under the bridge down by the river with Chris Farley. Large losses don't just hurt, they permanently alter the game. They shrink your future opportunity set.

• 13:12Speaker 00

  Good sizing avoids large losses, not because losses are bad, losses are inevitable. It avoids them because ruin is irreversible. And guess what? No surprise, TrendFollowing understands everything I'm talking about today far better than other trading approaches. Because TrendFollowing accepts that one brutal truth. Most trades will not work. If most trades fail, size becomes everything. Trendfollowers, we survive because losses are small. Winners are allowed to grow and no single one trade makes you. I mean, bet sizing creates asymmetry, as Larry Height would say.

• 13:56Speaker 00

  Diversification is just a sizing tool in disguise. It's not about owning many things, it's about controlling exposure. If every position is sized correctly, diversification happens naturally. If the size is wrong, diversification is an illusion. Practically speaking, high volatility means smaller size. Low volatility, larger size. Ignore volatility, eh, kind of like betting on a blind person. Look, what I'm talking about today is not optional, it's arithmetic. Once you accept that, once you stop trying to feel right and start trying to survive, you're forced to confront the final uncomfortable reality.

• 14:39Speaker 00

  Even correct sizing feels painfully slow in a world addicted to immediate results.

• 14:45Speaker 00

  And that impatience is exactly why most people abandon the one thing that could have saved them, which of course is sizing. But you know, one of the big enemies of correct bet sizing or correct position sizing or risk management, one of the big enemies? Boredom. Boredom creates doubt. People start saying, is this too conservative? Am I wasting my time? Am I missing opportunities? Shouldn't I be more aggressive? Those kinds of thinking, that doesn't come from logic. That's not the scientific method. That's from social media shit. Comparing yourself to some anonymous bullshitter on X. Come on. In the online world, what do you see? You don't see the risk. You don't see the drawdowns. You don't see the eventual collapse.

• 15:31Speaker 00

  You see the excitement. People want their trading to be personal. The outcome is their identity. The loss is threatening. But keeping your bet size small? That keeps trades impersonal. And impersonality is an edge. Again, this is why trend followers obsess over how much to bet. Trend followers accept what most people just refuse to accept. Most trades will not work. Not some, most. And if most trades fail, then the only way to survive is to make sure failure is freaking cheap. If failure is expensive, you're probably not listening to me anymore. You're probably out there working at Home Depot or the Amazon warehouse, trying to get money back to play

• 16:16Speaker 00

  the game again. And this is universal. Bet sizing in careers, business, health, relationships. Bet too big early and you lose optionality. Quit a job without savings, start a business with no runway, over commit emotionally too fast, neglect health until it collapses. All negative asymmetry. Small, repeated bets compound. Learning while working, building while earning, training gradually, testing before committing. That is positive asymmetry. You know, the ultimate paradox here? The less you need to win this trade, the more likely

• 16:56Speaker 00

  you are to win over time. Urgency disappears. Judgment improves. Discipline stabilizes. Bet sizing removes desperation. Desperation is what the markets take as their edge. That's what they exploit. The markets exploit your desperation. And the moment you say, “Hell, I don’t want to be desperate anymore,” then you’ll probably get rich. If you size correctly, brilliance doesn’t matter, insight doesn’t matter, effort doesn’t matter. That’s why smart people go broke. Not only because they’re wrong, they bet too big. The boring secret is not a trick, it’s discipline.

• 17:39Speaker 00

  And discipline, applied quietly, repeatedly, without urgency, is the only edge that compounds over a lifetime. See you again next week. I see a time when those awake will understand how to make money in up, down, and surprise markets. Whether a new trader or experienced, college student or financial advisor, protecting against a crash or just trying to make a lot of money, trend following offers everyone an answer in uncertain times.

• 18:21Speaker 00

  To get started immediately, send me an email, [email protected]. I will send you the right trend following steps to take, along with my free video. But if you want to buy and hold, trust the government and trust Wall Street, this is absolutely not for you.