Monroe Trout was one of the most consistent traders ever interviewed by Jack Schwager. He retired a long time ago in 2002 with a fifteen year record of 21.5% compounded annual returns, no losing years and just 6 negative months out of his last ten years of trading. Trout devised a simple risk management routine that helped him generate some of the most consistent market beating returns in the history of the business. In his interview with Schwager he fully disclosed his methodology and it would suit everyone to pay attention to his approach. Never lose more than 1.5% of equity on any given trade. This is excellent advice from every possible angle - psychological, financial and mechanical. Almost every retail speculator has encountered a trade that ate the account. This is usually some innocuous position that often starts out small, but for whatever reason - mistimed entry, surprise reversal in direction, botched execution - becomes a bigger and bigger bleed on the P/L blotter. How many of us have nursed a miserable position out of stubbornness that eventually cost us half of our equity or more? The 1.5% rule is a perfect cut off point because it is painful enough to make you pay attention but not so painful that you will hesitate to cut off the trade. The rule is even better if it is translated into a hard dollar amount. On a hypothetical $10,000 account the cut off point becomes 150 dollars. Note, that you need to distinguish between the percent stop on your equity and the percent stop on your position. You may want to trade a long term equity idea and give yourself a 25% stop on the position. In that case you simply need to size up the position in such a way that the 25% position stop does not exceed 1.5% of your total equity. This is even more true with short term trades on highly volatile instruments like Bitcoin which can move 20% intraday. You need to size up each trade properly so that a stop out on the position does not exceed 1.5% loss of your total capital. Stop trading if you lost 4% on the day. Some days the market loves you. Other days not so much. Choppy price action can frustrate even the most patient momentum trader and relentless rallies will destroy any mean reversion strategy - no matter how well it traded in the past. Trout, who was a college basketball player believed in streaks not just in trading, but in most things in life. As he told Schwager, “If a team has won eight games in a row, you don't bet against them winning their ninth game.” Monroe was the ultimate momentum trader, but as someone who appreciated the possibilities of a good winning run he also held tremendous respect for the destructive possibilities of a cold hand. That’s why the 4% rule is such a great risk management technique. It acts as a circuit breaker. IT FORCES YOU TO STOP LOSING MONEY. For every one in a hundred stories of traders coming back from the dead after seeing a large part of their account wiped out there are literally 99 out 100 stories of traders losing all of their equity by fighting to the bitter end. Walking away from the screen and starting without any prior positions on the books provides a mental cleanse that could help you get your groove back quickly. Stop Trading for the Month if you Lose 10% of the account This is the final circuit breaker that is designed to ensure that you can regain control over your trading. We have all seen the Table of Doom statistics of negative burn. If you lose 25% you need to make 50% just to get back to even. If you lose 50% you need to double the account just to get your initial money back. At 75% loss your chances of becoming profitable are down to a fraction of one percent. That’s why the 10% cutoff is such a good reference point. It’s wide enough to let you trade without obsessing over every tick, but small enough to preserve the vast majority of your equity. Furthermore, such a big loss is a clear indication that there is something wrong with your strategy or something wrong with you. Taking the rest of the month off and trading on a demo is a good way to pinpoint the problem without adding any further pressure on yourself. The markets will always be there. You need to make sure that you will be there to trade them Addendum. All the following rules and percentages presuppose that you are trading with your full size speculative account. A typical retail speculative account is $10,000 so I used that number for reference purposes. If however you trade as I do with just a fraction of your speculative capital in your account you can adjust the risk parameters accordingly. For example, if you trade with just 1,000 dollars of your equity you can adjust the risk settings to $150 per trade and $400 per day. If you get blown out for the month you will naturally have to stop as 10% of your equity will be drained. One of the key advantages of this “fractional” approach is that you never come close to breaching limits and this is why I like trading this way. But regardless of how you set up your account Monroe Trout’s rules of risk control should be the foundation for how you trade for life.
Great advice, I would go even further if someone is a trader (investors all totally different game) risking 150 basis points is way too much. I would risk even less on any single trade.
The solution for this particular issue is easy - full automation. Algos have no emotions, they just trade.
He also forgot to mention that it helps if you start your trading career in the depths of october 1987 and in front of a 13-year bull market. His result would be much different in 15-year period 1968-1983 or 2000-2015.
Here's SR's take on the situation... Stock Position Sizing Calculating Stop Risk vs. Reward https://www.elitetrader.com/et/thre...t-right-here-baby.335635/page-21#post-5406797