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The Dangerous Secret of Big Position SizesBy Brian Hunt, editor in chief, Stansberry & AssociatesMonday, October 12, 2009 When you have tremendous conviction on a trade, you have to go for the jugular. It takes courage to be a pig. – Stanley Druckenmiller
This quote is the financial equivalent of nuclear energy: a source of tremendous power that can be used to drive progress... or to cause complete destruction.
It's so dangerous, I debated not publishing this piece.
But I'd be doing you a disservice leaving it out of the informal "best trading quotes" series I've been writing each Monday. You see, this idea is one of the keys to making a fortune in the stock market... the idea of being a "pig."
Stanley Druckenmiller is one of the most successful money managers of all time. He earned an estimated $150 million in 2008. He learned much of what he knows from legendary speculator George Soros. That's where he learned to be a pig.
There's an old Wall Street adage that says, "Bears make money, bulls make money, but pigs get slaughtered." The idea is that you can make money when stocks go down (the bear side) or when they go up (the bull side)... but anyone who behaves like a pig – who gets too greedy – is destined to lose.
Soros and Druckenmiller don't agree with this line of thinking. They know that to make tremendous returns, you have to back your best ideas with large positions. You have to get greedy when you find an amazing risk-reward situation. Hitting a big trade with a tiny position size just doesn't generate big returns. You have to be a pig.
But here's where this idea gets dangerous...
The No. 1 cause of catastrophic losses – the kind of financial blow that will bankrupt someone – is losing a big percentage of a big position.
So why would I encourage you to learn about this weapon of mass financial destruction?
Because used correctly, a large position size in a great idea can make you rich. Because being a pig can make your year, doubling or tripling your account. It can be the difference between making $20,000 or $200,000 on a big trend, like the monster 500% move many gold stocks enjoyed from 2003 to 2008.
Normally, a trader should avoid putting more than 5% of his money into one idea. If you use a stop loss of 20% on 5% position, you will only lose 1% of your total portfolio if you are wrong.
But occasionally, when trade is close to "slam dunk" territory – when the reward-to-risk ratio is 6, 8, or 10 to 1 – a large position size of 10% or 20% of your portfolio allows you to make huge gains. The way to build superior long-term returns is through your "home run" trades... which must be backed by real money... not a 3% position.
Someone who isn't comfortable taking losses and minding their sell discipline should never take large positions sizes. If you can't cut losers short, you're playing Russian roulette when you take big positions. It's only a matter of time before you're toast. And if you're not good at recognizing great high-reward/low-risk trades, then please keep your position sizes small.
Only after years of successful trading and mastering stop losses should you even consider a position size greater than 5%.
But if you have extensive experience under your belt, you need to brush off the old Wall Street wisdom and pay attention to filthy rich traders like George Soros and Stanley Druckenmiller. You must make big money on your best high-reward/low-risk trades. You must be a pig.
Good trading,
Brian Hunt
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