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August 1, 2023

Portfolio Heat

Ed! I have a question for you if you'd indulge me:

Recently I've been making some day trades and for nearly all of them, the position sizes have been well beyond 'maniacal' (one of the archived posts characterizes 5% as such).

I've read so many cautions against crazy risk taking from you and other sources, all of which makes perfect sense and makes me want to adopt for my trading.

And yet I've ignored all of it in pursuit of gains. Should I stay away from the markets until I can abide by reasonable position sizes?

Or, (here I realize I'm trying to rationalize behavior) is it reasonable to say that the difference in magnitude between smaller accounts and professional funds/accounts means that the weight of a 1% risk isn't the same?

I feel that if I were managing a professional account I'd have no issue staying within 1% risk per trade.
Thank you for raising the issue of portfolio heat.

We can define heat as the ratio of portfolio risk to portfolio equity.

Trading systems that use stop-loss orders can compute heat as the ratio of stop-out equity (what you have left if all your protective stops execute) to portfolio equity.

Systems that do not use stop-loss orders may use other methods to estimate risk.

You may also define the heat of an individual trade as the ratio of its entry risk to the total equity.

Professional commodity traders generally keep their individual position  entry risk somewhere between .001 (one tenth of one percent) and .005 (one half of one percent). They generally keep their total entry risk below 10%.  Some successful traders may exceed these guidelines.

Total portfolio risk may run higher, especially in strongly trending markets where the risk initially follows the growth in open profits.

If you find yourself operating outside these bounds, you might ask to what extent you employ the excitement of volatility medicinally, as a distraction from having to look at deeper issues such as right livelihood.

Day-traders, heavy pornography users, drug addicts and various other types of thrill seekers share a similar physiological relationship with dopamine.

Fighting addictions through abstention might work - although withdrawal generally amplifies the pressures to continue using.

The Trading Tribe Process (TTP) works by locating and re-introducing you to right livelihood.  In the process the craving for dopamine seems to up and walk away.

You might consider taking your feelings about volitility to Tribe as an entry point.

Astute Traders

monitor overcharging.

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