Suppose you are trading a strategy, making decent money, executing your plan precisely, and everything is going well. You want to scale up your trading by increasing your position size.
Let’s talk about how to scale up your trading and some of the risks involved.
Contents
Introduction
You probably are thinking, why in the world do I need to read an article on how to scale up?
Instead of trading a one-lot iron condor, just put two extra zeros and trade a 100-lot iron condor.
No, no, and no.
You can not go from trading a one-lot to a 100-lot.
I don’t care how big your account size is.
That is like taking a person who does arm curls with a 10-pound weight and, all of a sudden, is lifting a 1000-pound weight.
Trading is not just the strategy; trading psychology also.
You need to get used to the larger numbers.
Instead of a $350 loss, you now have to be comfortable with a $35,000 loss.
Suppose your strategy rules tell you to cut losses if you are down 15%.
If you are used to cutting losses at $500, it will be difficult for you not to start cutting losses when you see a P&L of –$27,500.
Even when the rules tell you not to cut losses yet, you exit the trade because the big red number is much bigger than you are used to.
Now you have screwed up the statistics of the strategy.
Like a muscle, you need time to build up your strength slowly.
Start all new strategies at the minimum size, such as a one-lot.
Then go to a 5-lot. Then a 10-lot. And so on.
Scaling Up Too Fast
There is a multitude of YouTube videos on the fiasco that traders got themselves into by inappropriately scaling up.
The one that really stands out in my mind is that of Seth Freudberg, head trader and director of the Options Training Program at SMB Capital.
Obviously, with this kind of credentials and having traded the Rhino, the Bearish Butterfly, the M3, and various other strategies, he knows how to scale up properly now.
He was re-telling the story back when he was just a young inexperienced trader, and he made the mistake of scaling up too large.
Take a listen to this video where Seth was honored with being a successful options trader of the month by John Locke.
While the entire video is worth watching, you can jump directly to Seth’s story 13 minutes into the video.
Seth even says to the audience, if you don’t listen to anything else, please take down this one note.
So I’m writing it down for you. This is what he said:
“if you look at a chart of 2006, right through to late February 2007. It is the perfect chart to trade iron condors. It was a slow up-grinding with reduced volatility, and the market would just chill out enough towards the end. So if you look at a chart, it goes right to February 2007. And it was the easiest chart to trade iron condors. And, of course, I didn’t know that. I just knew that I kept winning every month. Can I ask everyone? If you take notes in these sessions, please take this one note, even if you fall asleep or anything else I’m going to tell you. Please take this one note. And it is this.
I’m not going to tell you the dollar amounts involved because it’s a nightmare. I went from trading a certain size account up until February. I guess it would have been the March 2007 iron condor expiration. I went from one level to a 2000% increase in capital.
I did 20 times. I don’t know what the hell I was thinking. I believe it was, “Okay, now I can start earning a living doing this.” So how much capital do I need? Well, I did the math. If I had this return these months, then you use this return; then at this capital level, you get this much.
As though the options gods were watching me, they were waiting for me to do this. And then there was this out-of-nowhere crash — crash-like thing. I don’t know what triggered it. I don’t remember. And I don’t think it matters. The market was down 500 points at one point, which, back in 2007, was a monstrous move. I didn’t know anything about not trading between 9:30 and 10:30. I didn’t know anything. And so, I freaked out. My put side was being hammered beyond belief. I freaked out. I closed the trade. If I hadn’t done anything, the market would recover like one hour later. I would have been fine. I do not want to tell you the amount of money I lost that day. Believe me. You don’t want to go through that.
It was unbelievably preposterously ridiculous that I increased my capital level to that extent.”
It Doesn’t Work That Way
What Seth did makes mathematical sense. If he was winning at a small size, then increasing the size should give him larger profits.
The late floor trader and author Edward Allen Toppel wrote in his book:
“Somehow, it just doesn’t work that way. When we increase the size of our positions, a funny thing happens. We usually begin to lose money. And a lot of it. It depends on how you increase your size.” source: Zen in the Markets: confessions of a Samurai trader
The psychology is that larger sizes mean larger normal losses — perhaps too large for the ego to handle.
He continues to write:
“The greater the size, the greater the pain when we are on the wrong side of the flow of the market. It’s easier to swallow our medicine when the pills are small than when they are big.”
Be Careful Of Euphoria
Risk managers in the industry have to watch out for the susceptibility of their traders to succumb to euphoria.
Clusters of good luck and bad luck occur in the market.
After a cluster of good luck, some traders become euphoric with the feeling of invincibility, a very dangerous condition.
Because this is when they abandon all their risk mitigation rules and throw position sizing out the window, they increase their position size too large.
And inevitably, the string of bad luck occurs.
FAQs
What to check before scaling up?
Obviously, your account capital needs to be sufficient to handle that increase in margin.
If you subscribe to the 2% rule, you have to ensure that the max loss on a single trade should not be more than 2% of your portfolio.
Second, you need to ensure that your current wins at your current size are not just from being lucky in an accommodating market.
You need to be sure that your strategy is solid.
Can you give an example of how to scale up properly?
Suppose one is trying out a new strategy.
- Backtest the strategy manually.
- Forward test it by paper trading it in real-time.
- Try it live in the smallest unit
- Log results, and when comfortable that you are executing it properly, backtest and/or paper trade it at the next size level.
- Then trade it live at this bigger size level.
- Repeat step 4.
By backtesting and/or paper trading at the new size before trading live at that size, you are priming your brain to get used to the larger numbers.
That way, you don’t “freak out” and make trading errors when you go live.
Is there an upper limit to how large one can scale?
Yes, there is. There is an upper limit at which point it is very difficult to scale any larger.
This limit will be different for each person depending on the risk tolerance.
But ultimately, we are all human and can not scale up indefinitely.
Are some strategies easier to scale up than others?
Most definitely. It is not uncommon for a trader to be able to trade a particular strategy at a large size while only being willing to trade another strategy at a small size only.
Strategies that produce smaller drawdowns can scale up more easily.
There are strategies that have such horrendous drawdowns that they could hardly be traded by most traders. A machine might need to be trading it instead.
Conclusion
Choosing your bread-and-butter strategy requires taking into account many factors.
It must be a strategy that fits your personality and that you like trading.
Plus, it must be a strategy that can be scaled up.
Once you find that strategy, now you will know how to scale it up properly.
We hope you enjoyed this article on how to scale up your trading.
If you have any questions, please send an email or leave a comment below.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
