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Monday, April 13, 2009

Think percentages not absolute $$$

I often see posts here on the slope convey the quality of their trades in straight out dollar figures. 

For example, "I made $20K today" or "I lost $6,500 on day trades". 

I have done it myself, but not very often, and I was reminded of an important distinction between thinking in absolute dollars won or lost vs. percentage of the portfolio. 

I myself almost always think in percentage terms and the good doctor reminded me why it is important to do so in his book “The Daily Trading Coach” :

"If I asked a trader how well he is doing and I receive a dollar figure as a reply, I usually know there's a problem afoot. 

Experienced traders think of their returns in percentage terms, not absolute dollars. 

Thus, for example, they might think of cutting their risk if they're down 5 percent on the year or limit their risk on a trade to 25 basis points (0.25 percent of their portfolio value). 

If you calibrate yourself in dollar terms, you will find it difficult to increase your trading size or to get larger as you grow you portfolio. 

Standardize your view in percentage terms and you make yourself more resilient; a $20,000 loss on a $2,000,000 portfolio won’t feel significantly different from a $500 loss on a $50,0000 portfolio. 

Similarly, when you cut your trading size, you'll standardize your risk management if you're calibrated by percentages, rather than let losses run because they seem small in absolute dollar terms.”
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