Editor’s note: Today we’d like to share an insight from Market Wizard and his colleague Larry Benedict.
It’s advice he learned in the early days of his career when he was trading on the Chicago Board Options Exchange in the 1980s.
And that has helped make it one of the biggest moneymakers in the world today…
The biggest and most important concept in trading is something that most novice traders completely miss.
It’s simple, but it directly contradicts the “quick money” mentality that gets most people interested in trading.
You have to “earn the risk.”
Let me explain…
When people are new to trading, they tend to go for ridiculous returns right from the start. They speculate on long-shot bets and squander all their initial capital. (I did the same. More on that later…)
I’m not saying there’s no place for such risky bets. They can be lucrative if you have the right plan.
But they have to be. cattle.
You should only attempt to place these riskier bets after you have made a profit from several smaller bets.
You should increase your capital with low-risk trades before shooting for the moon.That way, you’re protected if the risky trade fails… and you can still continue trading the next day.
That’s what keeps you sustainable.
What usually happens is that a trader goes on a losing streak… gets frustrated and emotional… and ends up losing more, even faster, because he doesn’t look to capture small profits to recoup his losses.
I have seen this happen to many new traders throughout my career, and it is one of the main reasons they leave the business.
Only when you have built a solid foundation will you have acquired the ability to take more risks. And if you are on a losing streak, you will have lost the ability to gamble with risk.
It really is that simple.
It happened to me too
I made big mistakes early in my career… and they cost me all my money several times over.
Actually, it was all due to a bunch of silly mistakes. One of them was position sizing.
I would bet too much on a risky trade and end up broke. After doing this a few times, I started trading with smaller lots.
But once I got further along in my career and had a solid capital base, I started taking on larger positions. At first, I could only handle 10 stocks. Then 100… 1,000… then 10,000.
Soon I was trading hundreds of thousands of shares at a time. Later, when I ran my hedge fund, I was trading positions worth millions of dollars.
That’s because I earned my risk. The lots I was trading grew along with my capital pile.
You see, I never looked at any position differently. It was the same mindset, no matter the size of the position.
I gradually increased my capital base and gradually gained the ability to trade more substantial sums.
And that made my capital grow exponentially…
Here’s an example: One of the most important positions I’ve held in my career was at Bank of America, in early 2009.
This happened when Bank of America was filing for bankruptcy and we were dealing with the financial crisis.
Then I saw an incredible opportunity. I bought $108 million worth of Bank of America stock in one go. I went in and bought 27 million shares at $4 each, near the bottom.
I made about $5 million on that trade.
That sounds like a huge return… But in reality it’s only a move of about 5%.
In other words, I made a profit that, in percentage terms, most traders would consider small… but it was worth millions.
To build your capital, those are precisely the profits you should be looking for on every trade. If you can make 5% several times a week, your trading account will start to grow exponentially.
That’s why I don’t get nervous about position sizes. For me, all positions are basically the same. That’s how I’ve done as well as I have.
Of course, Bank of America was an outlier. For me, it was a very important position.
But it was a once-in-a-lifetime opportunity. There was a global financial crisis and I saw the perfect opportunity to take advantage of it.
But I had cattle That risky business is slowly increasing my capital until it reaches hundreds of millions.
Even if you start with a trading account of just $100, you can do the same. It’s all about playing it safe until you win the risk… and so hitting that life-changing home run.
Good trade,
Larry Benedict
Editor, Trading with Larry Benedict
