To risk or not to risk, that is the question. One has to risk money to make money. Is it better to survive losing streaks and risk small amounts of capital on each trade, or risk a lot of capital and really make a big win? There is not a single right answer to this question. (And, even though we sometimes take strong positions at Innerworth, we truly believe that there is never just one right answer to any question.) Whether to risk a lot of capital or a little capital on a given trade is a personal question that you must decide based on your capital, your lifestyle, and your personality.
A few weeks ago, we presented the case of Allen Brunet who had $50,000 in his trading account. Allen was thinking about trading full time, but to do so, he had to make $20,000 a year to meet his daily living expenses. We argued that it might not be a very good idea for Allen to quit his job just yet. A return of $20,000 on a $50,000 account would be a 40% return for the year.
It may be difficult to achieve such a return, considering that many professional fund managers seem to think that a 20% return is very impressive. As we said previously, it isn’t impossible to make a 40% return. Indeed, we noted that Tom Baldwin started with an initial stake of $25,000 in 1982 and had personal expenses of $36,000. He obviously made quite a bit more than a 20% return on his money.
In the end, it comes down to personal preference. For Allen Brunet to make a 40% return, he would need to be willing to risk a great deal of his capital. Too those traders who have low-risk tolerance, risking such a large percentage might be unbearable. But, for those who have a high tolerance for risk, risking a great deal of capital on trade may seem worth it.
Some traders make the argument if you clearly know you are right on a trade, why not risk a lot of capital on it? That is not to say that traders should falsely believe that they are right, but rather, if after doing a substantial amount of research and preparation for a trade if they believe it is one of the best trades of the year, why not risk a lot on it? This is an argument worth considering. However, it is important to consider the downside. If you lose, can you afford to take the loss?
If you risk such a large amount of capital, do you have the personality that can continue to objectify the trade, look at it in a calm and unemotional way, and continue to make logical decisions after the trade is executed? If the answer to these questions is “yes,” that’s great. But, if the answer is “no,” then you must adjust your trading style to suit your personality.
Trading small positions, and thus, risking little on any given trade, can take a lot of the pressure off. Even if you don’t have much of a tolerance for risk, if a position is small enough, it is easier to manage one’s emotions and stay calm and rational while entering, holding, and exiting a trade. To each his own, but whatever you decide, think of the consequences and make sure that you can live with your decision.