Learning To Protect Your Capital

[Soultrader]

Preservation of capital is king in any business that involves risk. My background as a poker player has taught me this at a relatively young age. Traders often tell you "When in doubt, get out". Similary in poker, "Fold the hand the moment you know you cant win".

In this example, I will be referring to a poker heads up tournament. In other words a 1 vs 1 tournament. Let's say both players start off with a 1000 chips, 20/40 blinds. In the first hand Player A loses 100 chips.

Player A now has a chip count of 900 and Player B has a chip count of 1100. Notice that Player B is ahead of Player A by 200 chips or approx 22%. Now if Player A loses 200 more chips in the next hand, the chip count would be 700 vs 1300. The difference of 600 chips is approx 85% of Player A's chipcount. If you take this into consideration, this is a HUGE difference. So Player B now leads Player A by 85% more chips.

Now imagine in the third hand both players go all-in. Player A wins and doubles up making the chip count 1400 vs 600. Notice that Player B has now lost approx 54% of his stack. Player B went from up 85% against Player A to being down 133%.

In a game of poker they say a player is still in the game with one chip left. True but what are the probabilities of winning with such a small stack? In a heads up tourney, chip count = power. Once you are down to 600 or less... the odds of winning decreases significantly. (against a good player... not those typical all-in type amatuers)

Presevation of capital is number one. There is no need to risk your house on one hand or trade. As long as I have chips in front of me, I am confident in winning. Why? Because I rely on skill in poker... one must have an edge. This should be the same in trading. Keep your losses small and push on a winning trade. One losing trade should not ruin your day and your psychology. Be mentally prepared to win and lose. As long as you have an edge in trading, your account size will grow with time. Never let any trade get out of hand.

[MrPaul]

Excellent points Soultrader...Here's a good thesis on Position Sizing if anyone is interested.

Worth the read

http://www.trading-naked.com/library...ion_sizing.pdf