A handful of trades make all the money. He found out which ones in advance.
Wizard Wednesday #5: the winners analysis, variable position sizing, and the discipline of only ever risking 10% of your net worth.
Chapter five turned $5,000 into $53 million, and the number I keep coming back to is a different one: he never had more than 10% of his net worth in his trading account. Every time it grew too big, he pulled cash out and reset. When he almost blew up (a million down to 500K), he took 400K off the table and kept going. That cushion is probably what made him a better trader, because risking a small slice of your net worth lets you take risk without flinching on any single trade.
But the idea I’m stealing is the winners analysis. He went through every trade and found most were a wash, made a couple grand, lost a couple grand, who cares. A tiny handful each year made all the money. So instead of only trading the great setups, he figured out what those exceptional trades had in common and sized them up. Variable position sizing. Normal trades get normal size. Trades with the winning characteristics get two, three, four times the risk.
Schwager noted other traders in the book said the same thing. Cut losers fast, add to winners. One trader last chapter found his edge flipping his losers. This one found it flipping his winners.
That’s what I’m going to test on our systems. We’ve run them for years now, so there’s enough data to mine every trade, find what separates the great ones from the average ones, and run a filtered version that sizes those up.
Read, distill, steal. Now I test it.
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— Michael Nauss, CMT, CAIA, CDMS