In my last entry last week I presented an simple yet powerful approach to picking your tier size based on the risk you take on a play. Furthermore, the blog entry describes how to go about picking a tier size that works well independently of what kind of stock you are trading any minute of your day. In this entry I want to address the issue of how to tie in the probability of your trades to your tier size.

First let’s start by discussing how to go about quantifying the probability of a trade. I wish there was a simple gadget that would let you put in some variables and it would spit out a number between 0-100%. That would just make trading so much simpler. How do we do it then? Personally, I try to gauge the probability of my trades using indicators: time of the day, futures, chart setup, identifiable buyer/seller, unusual volume, support resistance level on different time frames, trend for the day, just to name a few. The more indicators I have in my favor the more confident I am about my trade. In a sense my level of confidence equates to the expected probability of the trade.

With that in mind we can tackle the issue of tying probability with your tier size. Rather than coming up with some fancy calculation for your size it is best to keep things simple. The best way to keep it simple is by using the indicators just mentioned as a way to add size to your positions. For each indicator that you have in your favor you increase your position by 1/2 and up to 1 more tier size. It is not so important how much size you add for each indicator in your favor, but what is important is that you do this consistently. You have to spend some time thinking about the best indicators that work best for your style of trading.

Obviously some indicators increase your risk in the trade more than others. But by adding to your position the moment the indicator is in your favor and hitting out the extra size the moment the indicator is no longer valid, you manage your risk quite well. The beauty of the system is that it makes it easier to scale into positions the moment it starts to go in your favor. It also keeps those marginal trades badly sized out of your game.

The rational behind this approach is simple. You start every trade with your normal position, then as you start to get confirmation then you add to your trade. It is not so much that the trade starts to work in your favor and then you add some random number of shares. You start to add size when you get confirmation from your indicators. The more indicators you have in your favor the higher the probability of your position and thus the bigger your position should get.

So there it is, my key to consistency. This is a systematic way to trade with a tier size independent of the stock that allows you to size up trades confirmed by your indicators. If you are struggling to find consistency in your results then revisiting your money management system is a must. Enjoy the rest of the weekend.