### Portfolio Heat applied to Day trading

Posted:

**Thu Nov 06, 2014 11:27 pm**My fellow Bloxites, I have been puzzling over an issue for some time and hoping some folks here may have a little wisdom to share. Sadly, the concept of portfolio heat applied to day trading is rarely addressed, based on my own scouring of the web.

Let me use a simple illustration here to highlight my issue: Let's say two brothers Fred and Ted both DAY trade only SP 500 stocks using the exact same methodolgy (trading logic). So if you show any 5 minute chart to each brother they will always agree on how many and where, if any, trade signal/entry(s) occurred and they would always agree on exactly how/where to exit all such signals. There is a difference between the brothers though, Fred is a little slower in the area of physically working the trades, and perhaps more importantly, to better understand his potential risk, Fred decided to limit his universe of tradable symbols to just 6 industry diversified symbols. Since he knows how many signals on average per day a symbol will produce and his dollar risk per trade he has a conceptual basis for understanding potential drawdown when things get really "bad" for all six symbols, day after day. Lastly, all the many decisions are completely taken out of his hands in that, he trades all signals for the day in whatever symbol/direction they occur. Ted, on the other hand, likes to have much more freedom in regards to which SP 500 stocks he will trade in and how many total trades he makes each day. His reasoning for using this approach is derived from 3 points: 1.Ted is very fast with all the skills needed for computer based day trading. 2. He has developed a "feel" for which stocks and direction he wants to trade by using his concepts of relative strength/weakness 3. Lastly, Ted has read several very good trading books and when they talked about expectancy and sample size, he read that if a trader has even a small expectancy then by taking "enough" trades each day that trader could maximize his chance of ending any particular day in the plus column.

I guess the first question that this example raises for me is : Let's say Ted is getting a little concerned about both his risk and understanding where the profit or loss is coming from in his trading, how could his trading be more controlled like Fred ??

What I have come up with so far has been

1. Ted could simply mimic Fred

2. Ted could establish a rule that says he can only have so many (at risk) trades on at any moment in time during the day. "At risk" meaning trades that have stops that are anything worse than breakeven.

3, Ted could make a rule that says he must, by the end of each trading day, have taken exactly 20 trades. This rule tries to normalize the daily exposure by trade count so all days have the same exposure to "good", "neutral" and "bad" days. And 20 trades might be the right amount, sample size wise, to give him a high probability of having a net profit day, which is very important to Ted. Note that all these solutions, except# 1, still give Ted some freedom on which symbols/directional bias to work with each day as he sees fit.

I hope this post creates a fertile discussion on what I think is an important but neglected topic. If I see one more web page on how to properly size a trade I think I'll go bonkers... Someone please help.. Thanks, Zoopy12

P.S. I purposely left out elements so the focus would remain on the topic of how the "betting" is distributed, and how that matters, if at all.

Let me use a simple illustration here to highlight my issue: Let's say two brothers Fred and Ted both DAY trade only SP 500 stocks using the exact same methodolgy (trading logic). So if you show any 5 minute chart to each brother they will always agree on how many and where, if any, trade signal/entry(s) occurred and they would always agree on exactly how/where to exit all such signals. There is a difference between the brothers though, Fred is a little slower in the area of physically working the trades, and perhaps more importantly, to better understand his potential risk, Fred decided to limit his universe of tradable symbols to just 6 industry diversified symbols. Since he knows how many signals on average per day a symbol will produce and his dollar risk per trade he has a conceptual basis for understanding potential drawdown when things get really "bad" for all six symbols, day after day. Lastly, all the many decisions are completely taken out of his hands in that, he trades all signals for the day in whatever symbol/direction they occur. Ted, on the other hand, likes to have much more freedom in regards to which SP 500 stocks he will trade in and how many total trades he makes each day. His reasoning for using this approach is derived from 3 points: 1.Ted is very fast with all the skills needed for computer based day trading. 2. He has developed a "feel" for which stocks and direction he wants to trade by using his concepts of relative strength/weakness 3. Lastly, Ted has read several very good trading books and when they talked about expectancy and sample size, he read that if a trader has even a small expectancy then by taking "enough" trades each day that trader could maximize his chance of ending any particular day in the plus column.

I guess the first question that this example raises for me is : Let's say Ted is getting a little concerned about both his risk and understanding where the profit or loss is coming from in his trading, how could his trading be more controlled like Fred ??

What I have come up with so far has been

1. Ted could simply mimic Fred

2. Ted could establish a rule that says he can only have so many (at risk) trades on at any moment in time during the day. "At risk" meaning trades that have stops that are anything worse than breakeven.

3, Ted could make a rule that says he must, by the end of each trading day, have taken exactly 20 trades. This rule tries to normalize the daily exposure by trade count so all days have the same exposure to "good", "neutral" and "bad" days. And 20 trades might be the right amount, sample size wise, to give him a high probability of having a net profit day, which is very important to Ted. Note that all these solutions, except# 1, still give Ted some freedom on which symbols/directional bias to work with each day as he sees fit.

I hope this post creates a fertile discussion on what I think is an important but neglected topic. If I see one more web page on how to properly size a trade I think I'll go bonkers... Someone please help.. Thanks, Zoopy12

P.S. I purposely left out elements so the focus would remain on the topic of how the "betting" is distributed, and how that matters, if at all.