This is meant to be a follow up to my recent Ed Seykota Quotes post where he states: ‘Risk no more than you can afford to lose and also risk enough so that a win is meaningful.’ In my experience lots of traders have difficulties applying this rule because they probably don’t fully understand the implications.
It is obvious you shouldn’t put all your eggs in one basket unless you are watching the basket very closely. Personally I like to diversify a bit but as a general rule I pay attention not to diversify too much and I keep my position sizes meaningful. The reasons why I do this are the following:
- You don’t lose focus.
- Fewer positions force you to be disciplined and do your DD.
- You are forced to focus on the best technical setups.
- No excuses. If there are two stocks you could choose from go with the better one.
Lots of traders fall for the perceived safety of small position sizes that ‘can’t hurt’. This reinforces bad habits. Losses aren’t cut fast enough because there is always the excuse that the loss is not significant. You get the picture. In the end they end up with lots of small positions going nowhere and tying up precious mental and financial capital. Check rule Number 3 in Gartman’s Trading Rules regarding mental capital.
Sticking to fewer stocks and spending more time on the selection process will increase your discipline and your focus. That alone is worth it as you are more likely to reach a ‘flow state’ where you only trade the best stocks with the best setups offering the best odds. Then you are able to trade at peak performance. I’ll write more about ‘flow’ in the near future.