In the last blog, we completed the formula for a normal position size and now we come to “Ebb and Flow”.
I discussed the idea briefly in the Art of Position Sizing. As Pete Steidlmayer said: “Risk is managed by knowledge – knowledge of self and of the markets”. ‘Ebb and Flow’ depends on having solid data base.
The analogy I use is to say that our plan is a beach front; the market takes the form of rolling waves that at times totally cover the beach (Flow State); at times totally withdraw (Ebb State); and at times partially cover the beach (Normal State).
The times when the waves totally cover the beach are the times when we can do no wrong. Everything we touch turns to gold – these are the results some system/seminar vendors use to sell their wares. You have read them: “Look! A 90% return in capital in only 3 months!”. The implication is this ‘golden touch’ will continue.
But of course it doesn’t. The waves start to withdraw. Our ‘golden touch’ turns to copper – with some wins and some losses. This is the normal state.
Finally the wave totally withdraws – nothing we do is right (the Ebb State). We sell and the market goes up; we buy and it goes down. Sometimes it seems the drawdown will never cease. But of course, this state also passes; and the whole cycles starts anew.
Our job as traders is to be:
- Super aggressive during the Flow State – I use Double Normal Size.
- Use Normal Size during the Normal State
- Be ultra-cautious during the Ebb State – I use Half Normal Size or totally with from trading.
How do you tell in which State you are in? You need to keep a detailed equity journal and learn to look out for tell-tale signs. One point is worth mentioning – we will always be late in identifying the Ebb or Flow. We identify an Ebb State only after a series of losses and identify the Flow State after a series of profits.
Tomorrow we’ll look at Trade Management and see how this ties in with Position Sizing.