Give and take of choosing your optimal bet size

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• 0:00Speaker 00

  Hey everybody, it's Michael Martin. Thanks for being here. So, listen, I have an email from someone, Roberto, and he wanted to know about bet size and if I could go at length about bet size and how do you pick it and this and that. And so, well, there's a lot to say. You know, to me, that's where fear and greed show up, is in how do you choose your optimal bet size? If you have FOMO or if you like the action, I see a lot of people kind of jumping in, buying things and selling things at the market as opposed to entering stops. But where fear and greed show up and hesitation or dreams of gigantic moves, look, I think it shows up in your bet size.

• 0:42Speaker 00

  That could be number of contracts, it could be number of shares. Now, does that make you a bad person? No, but so you have to think about this. When you set your goals, like what do you want your money to do for you? The bet size is the vehicle, right? That's going to get you there. So you really have to think about what it is that you're doing. You can't just say, "Well, I'm going to risk half a percent" because you don't know what the optimum level is. Now, backtesting can certainly give you a great idea on how your strategies could have done. Can you hear me okay? Is this thing, this thing looks good, yeah, okay. That will show you like what would be your compounded annual growth rate, this, that, or the other thing. It also will reflect like what's your drawdown

• 1:27Speaker 00

  when things aren't working out your way, right? So the bigger the position, obviously, the more money you could make. But when you flip the coin and it comes up tails, which it will from time to time, you have to anticipate that you'll go into drawdown. With bigger positions, you'll go into bigger drawdowns much faster. So I had to play with this for a while, right? Like, it's just like, you know, painting or doing anything else in your life. The, your style isn't something necessarily that you're born with. I think you have personality traits that you're born with that will come out of hiding every now and then. But your style of trading, just like your style of painting,

• 2:10Speaker 00

  is something that would emerge over time, right? From doing it. So that's why goal setting is so important because most people just like, "Well, I'm just going to do it." But you, to me, you have to be intentional about everything. That's how I've achieved any of my goals, is I actually sat back and thought like, "Okay, where do I want this to go? What's the trajectory? How fast do I need to get there? Can I accelerate and can I decelerate?" So I had tended to trade bigger positions when I was younger. And what I did was, when I started going into drawdown, I would cut the risk and go flat. And that was partly because there were a lot of commodities in the portfolio.

• 2:53Speaker 00

  And the old saying was, "You never meet a margin call," right, your maintenance margin call, right? Everyone, as soon as you buy gold or buy the S and P, you have a margin call. You know that. The maintenance call is the one that you don't want. That's when you're hemorrhaging or losing cash and they say, "Hey, you need to put more money in in order to maintain this position." Rule of thumb is, is that you never put in cash to meet a margin call. You offset the position that you're losing on, right? That's kind of, do what you want, but that's the rule of thumb right there. So at the end of the day, what I would say is, you know, put some thought into how, not only how much you want your money to grow, but how much do you of a drawdown can you withstand?

• 3:36Speaker 00

  Because that's where you really have to learn to play defense. Now, so for me, with commodities, I would cut them very, very quickly because they can move sharply and things can get ugly very quickly because of the implied leverage. So at the end of the day, you know, I picked judicious lots with stocks. I typically traded a minimum of 100 because in those days when I started, there would be, like I said, odd lot fees. They'd charge you $25 for buying less than 100 shares, even though that was probably like really appropriate for you to do. So, you know, the street has a way of exacting its money from you no matter what it is that you want to do. So at the end of the day,

• 4:19Speaker 00

  put some thought into that and say, "Okay, I need to make this amount of money, but I also know that I can't withstand this type of drawdown." And I don't know what that number is. Maybe for you it's 15%, maybe it's 25%. Maybe you know you're going to be coming into more and more sums of cash. So you're ready, willing, able to risk, you know, 40, 50% a year because you really want to try to double your money. And that's okay, there's nothing wrong with that. Just understand that your position size says a lot for, you know, how your account's going to perform. So in order to temper larger positions, knowing that I was going to go to cash the minute, you know, my, the old joke I used to say, it's not so much a joke, but I would say like, if I smelled smoke,

• 5:04Speaker 00

  I was, I would assume it's a five alarm fire. And that was just because I knew I could think more clearly if I went to cash as soon as possible, right? Now, if something happens and the market jumps and you can't make your move before, not that it's too late, but before you could, you could preserve more of your capital. They always say that your first loss is your best loss. So what I would do in that case is just say, "Hey, market didn't work in my favor today. It moved sharply, I got to get out. It's going to happen once in a while." That's the way it goes. So what I want you to think about is, think about your position size as it relates to the drawdown, not so much your compounded annual growth rate, right? Because if you have even mediocre timing,

• 5:49Speaker 00

  you'll be in the right place at the right time. The question is, how do you know you're wrong? When do you know you're wrong? And then what do you do about it? So that's why I always traded with stops. I always had protective stops in and just almost as a hedge. Like I would throw out like chum. I would have buy-stop orders across any number of instruments because I knew that, like, say I had a dozen buy-stops in above the market to enter the market long and establish initial positions. Nine or 10 of them wouldn't get hit. Not because they were so far away, just because that's the nature of the markets. Like, they just wouldn't get to the levels where I needed them to get to. And if that didn't happen, that was good. With that in mind, I will say as an aside

• 6:34Speaker 00

  that when you put in buy-stops above the market and the market doesn't get there, that's actually a good thing because now you're not, you're not chasing, but it shows that the market didn't exhibit the strength that you needed it to. So a lot of times I put them out there to kind of get a feel for the market and say, "Okay, who's really in control here? Let me put those, those orders out there." Again, with usually a teaser. I didn't put my optimum size on it first. I would much rather kind of get in with a smaller piece. This way, if I got whipsawed, which is bound to happen, I could get out with a much smaller loss because I knew my capital was limited. Now, as it relates to these funding accounts, I want to be completely frank with you.

• 7:18Speaker 00

  When I look and see what some of the rules are, I could never pass these trading challenges. My, my, the movement of my, my account balance, even today, is far too rich for what those rules would ever accommodate. And I'd continually get knocked out. Now, I know there's conspiracy theories and I'm kind of like on the fence about them where someone was saying that, and I've said this too, right? That in, in order, where are they getting the money from? Because I don't necessarily think that they're actually piggybacking your trades. I think they're taking the fees that other people who can't make the hurdles every month

• 8:02Speaker 00

  or they can't put in the number of trades, right? So the kind of penalizes you for having a unique style. You have to have a style that just so happens to align with those rules. So if I started with a small position, maybe on a $50,000 funded account with, you know, bogus 50K, I might not make enough money because of my initial position sizes if there's no follow-through. Because when I'm starting, I'm really trying to play defense, right? I'm trying to play defense to make sure that I don't get too ahead of myself and kind of fall in love, you know, with the girl in the picture, so to speak, meaning the chart. So I temper that and then what I do is I add. So I'll have a bigger position,

• 8:47Speaker 00

  but at that point, I'll have unrealized gains that I can reinvest into my protective stop. So I'm not really playing with the market's money because I always look at it as mine even though it's an unrealized gain. It's my responsibility to manage the risk with that. So I don't, I like to get as big as possible and I will add three, four, five times or whatever, maybe six times in recent times, you know, to a trade. But at the end of the day, the goal is to protect your capital. Even if you're completely hell-bent for election as a speculator, I think number one job is to play superior defense. And so, you know, backtest your ideas. It's better to do it at the portfolio level, not just on a one instrument at a time. And please look at 10 years.

• 9:31Speaker 00

  Two years isn't going to mean anything. You know, you have to think and stress test your ideas in the worst of times. Like, what happened in '22? What happened in '07, '08? What happened around 9/11? You know, what happened during COVID? Those are, those are where, right? You'll, you'll really get to see how you did or how you could do, given your position sizing. And that might be eye-opening. So if anything, I would say, err to the conservative side. It might not be what you want to hear because everyone wants to get big and make a lot of money. But you have to understand that if you lose a lot of money, it'd be very destabilizing emotionally. Not just losing your money, but now you've lost your confidence, you've lost your nerve, you don't know when you could get back up. And yes, they've taken away the 25K PDT rules

• 10:16Speaker 00

  or whatever they are, pattern day trading, you know, thing to trade four times capital. But for goodness sake, if you can't make money with, say, 10,000 in cash, why are you going to try to trade 40K on margin? You know, that doesn't, that defies, defies wisdom, I think. So spend a lot of time meditating, mostly though, that it's, your position size in and of itself is a double-edged sword. You see? So it can help you, but it could also hurt you when things don't go. So just be mindful of, of what you're putting up at first. I mean, I can get big, but I don't start big. So I'm kind of a scaredy cat. But I'm kind of like wading out into the water before I'll dive in and put my head under, so to speak. So that has served me well.

• 11:00Speaker 00

  But it also means that I'm going to be buying more at higher prices, which I'm very comfortable doing. Because for me, you know, I'm, I'm not trying to worry about what's the highest high that it could possibly go. There is no upper boundary, right? So that's what I would do. Tomorrow, we're going to talk about money management. But anyway, check out the link below for the cohort. And thanks for being here, I'll see you tomorrow.