Position Size: When Is it Safe to Increase?

Mark,

You
bring up an interesting point about increasing position size. You
mention increasing to two kites with a max of 20-lot of iron condors. But assume
that you don't use kites to protect against excessive moves, and
prefer covering part of the position to reduce risk.

By how much of an
increment would you recommend increasing your position size if you're
used to trading 10 lots? And once you've become comfortable with the new
size, how frequently would you consider increasing size again and by
how much? This assumes limited capital constraints — within reason of
course.


Thanks,

Burt

***

Owning insurance allows a minor size adjustment.  But it's minor.  Insurance does not guarantee that you will not incur losses.  If you trade without insurance – as most do – size increase can only occur when it is justified.

My basic philosophy of trading is involved with this answer.  There's more of that philosophy in Lessons of a Lifetime.  I caution you to find a trading philosophy that suits you, and not blindly follow my suggestions.  The reply below is based on my comfort zone and experience.

1) Do not increase position size until you believe you understand how to manage risk for the strategy (or strategies) being traded.

2) Be certain that you get the nuances of the strategy and that you are comfortable with your positions and confident that you can earn money using these methods.

3) As a side issue:  Most people who trade have no idea that the average result for people who try to become short-term traders is to lose money.  That's the average result.  Most never become profitable.

I don't know how true that statistic is for us.  As option spreaders, we hold positions longer than the short-term trader.  Our success does not come from reading short-term trends.  It comes from managing risk efficiently and adopting methods that are appropriate for our psychological needs.   I suspect than earning any reasonable profit represents an above average result.

4) Before you even think about increasing size, you must be profitable.  Comfortably profitable.  Only you can determine what that means, but it does not mean earning $50 per month, after expenses. You must be able to see your account value increasing.  If you are withdrawing money for living expenses, then it's especially important not to increase size and jeopardize a significant portion of your account.

Although it may not be easy to determine, I'd want to know that profit did not result only from good luck, but instead was based on action taken or decisions made.

5) You must have faced several risk management decisions and handled them effectively.  If it all went smoothly and you had no pressure and no tough decisions, you have no method for measuring your skills.  I know that a string of profits is encouraging, but it is not enough to begin trading larger size.

What's a good decision?  It's not that the 'adjustment' made lots of money. It is knowing that the decision accomplished your risk management objectives:  it reduced risk, it resulted in your owning a position that met your needs and fit within your comfort zone.  It means you did not take defensive action just to do something.  It means that you wanted to own the newly adjusted positions and did not own it because it was 'the best' you could do. Furthermore, it means that additional handling of the position was done carefully and intelligently.

6) If you pass those tests, next comes your comfort zone.  Try a 20% increase and trade 12 iron condors, and remain at that level for several months.  When you believe you are ready to move to larger size again, repeat the entire process. 

Carefully examine what has been happening.  Do not rely on 'profits' as the sole factor that determines how well you are progressing.  Examine the same questions you tackled earlier.  If you do not find proof that you are handling the positions skillfully, do not increase size.

Yes, that advice is easy to ignore when you are making money.  But if you cannot prove to yourself that you have been skillful, rather than lucky, trading larger size will make things more difficult.

7)  Here's the problem:  If the market is kind to iron condor traders – as it is part of the time – you can get lulled into a false sense of confidence and when it hits the fan, you may have too much size to handle comfortably.   It's really easy to lose a year's worth of gains in a hurry – especially when trading too much size.

8) Don't ignore the size of your account.  I note that your question does take this into consideration.  But overconfidence can bring big trouble.

If your account value is not growing steadily, then it's too soon to increase size. No matter how much you decide to risk on a specific trade, it must never be large enough to jeopardize your being able to stay in business – if something terrible happens.  And it will happen – if you trade long enough.  You can own insurance to offset the major part of the problem, but that's not a cheap fix.

653


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