Strategies for Small Accounts
Everyone, welcome to another episode of Line Your Own Pocket. So last time we talked a little bit about, you know, getting started with a small account and ways to potentially get funded and and setting expectations and things like that. I think today we're gonna talk a little bit more about just the nitty gritty of, you know, some potential benefits and and workarounds and how you would trade a small account. And because we're doing these kind of back to back, we haven't seen the feedback of the first one yet, but keep those coming because I do think this will be kind of a hot topic and we would love to get your feedback and then maybe, you know, down the road, we'll revisit it again a little more.
Dave:Yeah. I think this is a it's it's a good topic that, you know, at first, I thought, okay. Well, I have to think back really far back to when I was just starting out. But a lot of the topics are timeless no matter how big your account is because you're you're, know, you're learning skills, trading skills that apply really no matter how big your account is. And the the better you get at that, the better you are as a trader.
Dave:So
Michael:Well, and I I I thought the same thing too. And I started to think of, you know, because I looked down and I see the size of my account and hopefully I know that I'm nowhere near $25,000 and I don't have to worry about that for the rest of my life now. I started to think about it on an individual strategy basis. I think this is something that will be interesting to talk about where the next strategy I employ, I'm not giving it my whole account right off the bat. You know, it it's so we can start to kind of put ourselves in that role and think about kind of anytime you take a strategy live, you should almost pretend you're in a small account right off the bat because you should only be giving it access to a certain a certain aspect of your account.
Dave:Yeah. I think that's totally true. I mean, the other thing I think people assume is that, okay, once they have a big enough account, like, it's all easy street or, like, it's a whole different world and it's just a lot easier, but it's it doesn't really get easier. It just, you just have different sets of problems. Maybe you have more flexibility, but you're still, everything you learn from even those early stages is cumulative and you can, you will continue to apply those skills, throughout your whole career.
Dave:So, and I think you're totally right. When you come up with a new strategy, yeah, you're not applying your whole account to it. It's like you, I think that's a great way to put it and a great way to think about it.
Michael:Well, that's why I wanna, I wanna talk a little bit about it. I did have some examples and I won't name any names, but I was, I've been following this, this one gentleman on Twitter who with it kind of made his account and and made his wealth through shorting kind of these low float penny names that have been in going crazy. And over the last year or so, there's been a handful of widowmakers with these. Like companies that have gotten halted for six months plus. If you're in them, your your money's just gone until whatever happens.
Michael:There's been a couple companies that have gone up 10000% in a day and, you know, things not managed correctly. This is another systematic trader that does this. And I've seen actually a couple of these mentioned where the idea is that he's kind of looking at his account now and saying this is how I got here, but do I need to be here anymore? Do I need to be risking this entire account that I've built up that's now and and he's public about it, you know, many I think it's over half $1,000,000 or so on these particular strategies or do I retire them entirely or do it now I kind of trade a subset of the account. And that got me thinking about kind of where I wanted to talk about in this podcast about how there's like you mentioned, there's kind of levels to it.
Michael:And there might be a place that makes the most sense to start when you have a smaller account. And then as you kind of build out strategies, you're just you're building on top of a building as opposed to going in different directions. And I think that's kind of an interesting way to start is. So imagine you're this person that we talked about last time and you've got $5, but let's say the pattern day trader rule doesn't apply to you. Right?
Michael:And for whatever reason you're in another country or in Canada with me or or like we talked about, they're starting to diminish that. That's your first account. The way I kinda look at that and the way I'm I'm gonna ask you about is I'm way more open to taking significant risks with that account as opposed to instead of $5,000, $500,000, or $5,000,000, or whatever the account ends up being later.
Dave:Yeah. So I think your point from last week about how, you know, the if you're gonna make mistakes, make them earlier. I think that applies here. And that's why it doesn't get, quote unquote easier when you get a larger account because the money you're risking is a lot more. So it's the mistakes can be even even worse.
Dave:And maybe you have more wealth. Maybe you you you can afford to absorb a bigger loss, but still it's there's there's phases you go through where you have to kind of acclimate to the sizing. You can't just like, all of a sudden, you know, you win the lottery, you've got a bunch of money, and then all of a sudden, you know, you you you think about money differently. Mhmm. You're still gonna have periods where, like you make some mistakes that you used to make at smaller sizes precisely because your size is, is higher now.
Dave:Like you're gonna, oh, my old friend of overtrading is back.
Michael:Yeah.
Dave:You kind of go through these cycles where you're up at a different size and all of a sudden the psychological issues are like some of the mistakes you used to make at a smaller size that you thought you got rid of have reared their ugly head again.
Michael:Well, that's why I I I'm so interested in this kind of starting point. Right? And I think all people, I'd say 90% of them, when they start with that small account, they look at it and then they kind of intellectually know there there's no way you're gonna make a living with the $5,000 account. But, you know, they hear the stories and and a lot of them are fake, but some of them are legitimate, like, you know, the Kuala Murray whatever who turned $10 into 80,000,000 or something at at this point. So these things can be done, and they kind of hold on to those, but it instantly starts with a, incredibly high risk kind of mentality of it of kind of because you're again, you know that, okay, for me to make anything out of of $5,000, I have to double it over and over and over and over again.
Michael:And to do so, the only way to do that is to take a pretty explosive risk. But I think that's not necessarily a bad thing as long as you're not going, you know, you're not blowing it up and going and going too crazy or gambling mode with it because it kind of acclimates you a little bit to the kinds of styles of trading that can work for small accounts, which are more illiquid, lower flow, you know, smaller cap stocks. And then well, first of all, do you agree? And then I the way I look at it is that a lot of people look at it as I'm gonna be then graduate from this. And what I think might make more sense when we talk about all the time and the benefit of systematic trading is that maybe you get to a point where like I mentioned with this one trader, where these things are just too wild for trading a half million dollar account, But why not continue to trade ten, twenty, thirty thousand dollars or whatever you were doing before there and then take your other $3,400,000 and and do a different set of strategies that hopefully are are somewhat uncorrelated to that and and kind of build out from there.
Michael:So, basically, I I guess I'm giving permission to the small account people to to go a little bit nuts in the beginning.
Dave:Well, to to be able to do that, you have to have be able to allocate money that you literally don't need. Like, if it goes to zero, that you have to be totally fine with that. Now when you get to that point and and you're gonna be at such an advantage to having that mindset because you'll have your your mindset's completely different if you need the money. If you don't need it, then you can you can take risks. You can you can you actually have a much clearer mind about things when you don't need the money.
Dave:So, you know, that it's
Michael:Well, I guess I'm also kind of making the assumption too, that I think in most cases would be fair, but maybe some cases aren't fair. That if you are starting out with $5,000, you're probably also relatively young as well. You know, I don't think there's a lot of 50, 60, 70 year olds, you know, entering the game now. I guess they could. They could just say, I'm just only going to allocate this amount of money to my trading and that'd be responsible of them.
Michael:But I I'm I think I'm just kind of assuming that if you are also in the small account world, then you're probably also in the younger side of things as well. And I think a lot of those things kind of go hand in hand with risk taking appetite.
Dave:Sure.
Michael:You know, I'm thinking of myself more in my early twenties where I didn't have much money, at the same time I also didn't have kids and a house and a wife and all that stuff as well.
Dave:And also time is on your side when you're younger, like you could make mistakes. You've got plenty of time to recover if there's, you know, if you ruin your account or whatever. So, you know, the stakes get higher as you get older. You know, the other thing I was thinking about this is you know, last week, I said that there are a lot of strategies that bigger players couldn't even consider that you could with a smaller account. And I think that's definitely true, but there's a big but there.
Dave:There's a bit of a chicken and an egg problem where to be able to trade some of these smaller strategies well, you have to have developed some good trading intuition and some skills to be able to make some of those trades with smaller liquidity names that requires some finesse. And you may not have those skills as a new trader. You're only gonna develop those skills the more experience you get. So there's a bit of a chicken and an egg problem there that I think you run into.
Michael:Yeah. Because I've heard that before where they say, well, I have a small account so I can trade lower liquidity things. But you're right. You're probably also a newer trader, and you may not understand things like bid ask spread and and putting limits out in the market and how much they have to sit there and and and, you know, things like that. And and looking at things like unrealized losses and not panicking too much because the spreads are just really wide.
Michael:So it's showing you something that might not be legitimate. And then again, also patience, I would say, you know, the person with the $5,000 account that's trying to really balloon it up into a lot, they might not have the patience to put out a, you know, a bid to get out of a a short on an illiquid name and know that it has to sit there all day. Right? You know, the chances of getting filled are are that kind of thing. So I'm definitely with you that the same problems seem to always remain.
Michael:It's, you know, and I've noticed this myself is my whole thing is overtrading and and revenge training. Like, I'm that's that's I think it's everyone's thing, but it's certainly it's certainly my thing. And then as my account grew, it was just more of the same. It was more of the and then the swings just kind of got bigger. And that's one of the reasons I went more more systematic and automated.
Michael:But I think the main thing and and the main thing to focus on is that as your account gets larger, you're either trading the same strategies that you're currently trading bigger or something that we talk about all the time. And I'm a huge component of is just trading more strategies as well. So I look at it as that you should start with one and then know that that strategy, the goal isn't to infinitely scale it to oblivion, but it's to take that one strategy and have that get you to some milestone. And then in in when you have kind of the free capital as opposed to just scaling it up over and over again, it's implementing that other strategy. So that's why I think even a smaller account becomes harder is because that one strategy you pick because you don't have the luxury of trading five or six or 20 different strategies.
Michael:That one strategy you pick that's gonna take up all your buying power. You've gotta make sure that that's the best one that you have access to at the time.
Dave:Yeah. For sure. I mean, it gets a lot easier to, like like I say so many times, wide versus scale up. So there's a couple of things that you reminded me of as you were talking there. One is as I traded my very first strategy, I had the R multiple concept down pat.
Dave:And it's such an important concept to have precisely because as your account grows, you can still normalize your performance across your, you know, back when your account was small versus now when you're trading it a lot bigger, your performance could be normalized across that entire period. So it's just a very powerful way to look at your performance across time precisely because of that. And I still see this in use now. I mean, a lot of traders that I work with will, you know, when they size up, they have difficulty because the swings get, of course, larger when you look at it in pure P and L terms. And that could be it doesn't matter even how much money it is.
Dave:It could be psychologically really difficult to see your P and L bouncing around, maybe even dropping below zero. But the strategy is working, and it's very clear to see that when you look at an equity curve in terms of our multiples because that's normalized over your sizing. So it's really a very powerful, not only data tool, but a psychological tool to say, okay, no, I can see I know what my P and L is doing. Let me look at this arm multiple. I can tell that the strategy is working as designed.
Dave:Like, I'm just gonna continue the course, and I know what the outcome's gonna be here.
Michael:Well, and that's, you know, we we had a whole video about kinda hiding your P and L, and that's that's a big point of it as well is that it is much easier to stomach large percentage swings with a small account. If you got $10 and you're up or down like a grand in a month. Right? That's that's easier again assuming that, know, you have a job and you're working whatever. But you're right.
Michael:It's very, you know, then all of a sudden, you know, say you have a $100,000 account. Well, a $10,000 swing up or down might be harder to stomach. A million dollar account, a $100,000 swing might be harder, especially because, you know, regardless of the size of your account for most of us traders, it's the majority of our net worth. So, you know, percentage moves make make a pretty big deal. And that's why it's so important, I think, to hide these numbers the best you can and just focus on our multiple because, you know, we're talking about often, you know, the young person starting out, but the other example I gave is the old post person who's maybe, you know, he's put $10 into his account and it's doing okay.
Michael:And then he, you know, fills puts another 90,000 in to put it to a a 100,000. Well, you're right. It's very possible that the next trade is p and l actually goes negative, but the strategy is still doing fantastic. So having that that zoomed out normalized, look, could look at it because yeah, because maybe the next trade loses $5 And but still, it's it's still a great strategy. So having these tools in place, I think it's the perfect time to do it is when you have a small account.
Michael:So you have just some sort of spreadsheet or recording mechanism that doesn't really focus on the absolute value of the trades. It's just saying this is the r that you made on on every single trade so that regardless of the size of your account, it's just a line number somewhere that you're just changing and and moving on.
Dave:Yeah. So it's really you know, this reminds me of RealTest. And I think I can't remember if it's the default, but at least I know a lot of people in RealTest, will do, position sizing based on the account. And in their backtest, with a good strategy, the account's growing over time. So the more recent trades have a lot bigger size, so they're compounding.
Dave:You need to turn that off when you're optimizing in the Cruncher, and that's the first thing I tell RealTest users. But it's a really good visual visualization to, to see exactly the phenomenon we're talking about. Because when you look at an equity curve, it's really clear to see, to recognize when compounding is turned on because like it's this tiny movement of for the first, you know, half of the chart. And then all of a sudden the moves are really big and like, well, yeah, that makes sense because you're compounding your, your account. And if you're not careful when you optimize based on that, you're just, you know, everything before a certain date is just going to be meaningless.
Dave:All the optimization is going to come from the more recent stuff. And that's not really what you want to do.
Michael:Well, and it's also important to, it's why a lot of like, technical analysts just for market charts, but also for equity curves. If you're not using, like, logarithmic charts, you're you're doing it wrong. Right? It it's a faux pas in the technical analysis community if you bring up like a thirty year chart of the S and P 500 and it's not log because just like you said, it looks stupid and people bring up like, look, the the market's gotta pull back. It's just it's ripping all the time.
Michael:It's like, yeah, but it's right? You're It's not law. It's on a log chart. It's an arithmetic chart, so it just looks dumb. So definitely a 100%.
Michael:Right? Do, you know, mess with the compounding. I think that's something for another day because I'd be interested to see I leave it on in some respects just because I want the more recent data to be weighted more. But again, that's a topic for another day. But
Dave:We could probably do a whole topic around that.
Michael:I was yeah. But in the moment every night because every now and then I'm looking at real tests and I hit l, which is the key to do it and the log turns off. And I do that because you have to look at it and say because there's one thing to look and say, oh, it's only, you know, the max drawdown on this is like 20%. That's great. And then you you hit the l button to turn off the log and you see, well, at some point that million dollar account, you know, drew down 250, $300,000.
Michael:And is that going to be okay? Right? Or are you are you going to be okay kinda sitting there in that losing that amount of money and coming in every day to hit that? You know, it really comes down to what we were talking about that these problems are just different over time. Give me a $5,000 account.
Michael:I'll stomach a 50% drawdown and and not blink an eye because you know where I am in my life give me a million dollar account and a 50% drawdown and I just probably would not be able to to continue to function through that to be honest.
Dave:Yeah. Alright. So there's a couple other things I want to touch on here. One is a mistake I made years ago which opened my eyes to what we were talking about before about, you know, trading skills, order types, what makes sense, you know, when you would use certain order types. And it's a very it was it was extremely clear to me in one moment with one trade why this certain order type was very valuable.
Dave:So let me just take you back. I started off trading a strategy that I I still trade to this day. I trade a gap strategy that, you know, stocks sort of gapping up or gapping down, wait for a certain range, And then I put orders in and, and I'm waiting for the, the stock to break the range. If it's in the range,
Michael:are we talking stop stop limit versus stop loss? Is that immediately when it
Dave:went? I was used. So for the first many years trading the strategy, I only used a stop order for entry. I always use a stop order for exit, but there was a stop order for entry. Right?
Dave:So if it broke the range, that's when I wanted to get in. If it didn't break the range, I, I wasn't interested in the trade. So many years I did this, the stock would activate. Yeah. I knew about slippage.
Dave:You know, I would get some slippage every now and then times,
Michael:most times a little slippage most times.
Dave:Yeah. So over time, you know, I was growing my size, trading this thing bigger and bigger. And then all of a sudden I had this one trade. It was a short trade. I don't remember the symbol name, pretty tight range.
Dave:I was like, okay, I can, I can lever up on this one because that's the way the system worked? I looked down, and all of a sudden, I'm down, like, 10 r in this trade. And I'm like, what the heck happened here? Well, it was right in that moment where I realized, okay, I understand now why a stop limit order would be useful here. And that's because the yeah, the stop worked as designed, but I didn't get a fill until, like, 10 r beyond my entry.
Dave:And then, of course, the stock went right back up and I got stopped out. So I had a 10R loss in less than ten seconds. And I was like, What the heck just happened here? Well, a stop limit, I learned really quickly. Okay, here's what a stop limit does.
Dave:Here's why you would want to use it. This is the exact situation because I wouldn't have got a fill, or I've got a partial fill and then, you know, the rest of it would have got filled back at that reasonable level and it would have been just a normal loss. So that's one of those lessons that, you know, a lot of people don't understand what stop limit orders are, but it became really clear in this instant why you would want to use one in this specific situation where you'd want to use one.
Michael:Well, and it's funny. I immediately recognize that not because I'm a savant, just because I've done the same, the same thing. And it's, there's some of these, I think, battle wounds that you just you just have to take at at some point. Right? And, you know, someone can sit down and tell you it's like, not to compare new traders to my three year old, like, I don't know how many times I'm like, don't do that.
Michael:You're gonna hurt yourself. And then I just hear a scream from another room, like, twenty minutes later, and I just go in. I just go, like, you did the thing I just told you not to do. And it's the same where anyone can tell you, yes, use a stop limit. It'll protect you.
Michael:And I think if the person immediately started to listen, what would happen is they would they would immediately notice the other draw down with stop limits, which is sometimes you just won't get filled or partial filled or whatever. And then eventually after getting nagged enough about that, they might, you know, change it and say, I'm gonna just use it as a stop market until they get hit on the other side and just realize which is worse. Right? Not getting the trade that turned out to be amazing or getting the trade that just, you know, completely kinda ruined the statistics of the system over for the next month or so while it while it makes money back out. And this is why, again, I think a lot of what we've been doing in these these two episodes is just encouraging people to, don't let the small account be an excuse.
Michael:Right? You know? Yeah. We talked about in the beginning about use most of the money to get the proper tools and start testing and building and automating and and mentors and things like that. But then also in this episode, think we're just we're permitting a little bit of of YOLO ing because I would much rather the guy with the $5,000 account or like we talked about that open the prop firm account for a $120 to get slapped like that than the person who puts half $1,000,000 into trading and takes a ten hour loss because the the mental weight of that is gonna just be way harder to recover from.
Michael:Maybe maybe you'll learn the lesson faster, I guess, but I I still wouldn't wish that on anyone.
Dave:Yeah. So it reminds me of so I listened to this podcast called econ talk. Doesn't have anything to do with trading. It's about economics. It's a guy that does it.
Dave:He's been doing it for years. His name is Russ Roberts. He's got a he talks about his dad and when he was growing up. And so at some point, there was a regulation that came along that said porches have to have railings up. It was a code to say, okay.
Dave:You have to have railings up on porches because kids could just go and, you know, they would maybe fall off the edge, right, and get hurt. It's like, yep. His dad was like, this is a terrible idea. The the the railings are literally preventing kids from learning a very valuable lesson on their own, And it's a much better approach to actually have some danger involved, not too much, but a moderate amount of danger so that they can learn these lessons. So I think there is like when you were saying sometimes people just have to learn themselves.
Dave:That's totally true. Like it doesn't matter how many times I had heard that or like to experience it yourself is really when you really learn it because you, it's very crystal clear why.
Michael:Yeah. Well, and it's one of those hopefully, right, it's touching the stove and and you don't do it again. And, you know, back for the example for my kids, it you know, moments like that remind me of just what you're talking about. It's like, I gotta let this guy take more risk. I just gotta make sure it's not permanent.
Michael:Right? Risk. Right? And it should be the same with your trading is that you should allow yourself to do these experiments just not with a game ending amount of of money, which is why, you know, in the beginning of this, I said, I I always wanna put myself in that example of doing things with a small account. And it's why we talk about, you know, some people just skip the paper trading part of this entirely.
Michael:I I do myself. But it just means that I I take that money and I just trade it smaller. So you should always kind of be even if you're an experienced trader with a large account listening to this, you know, take yourself back to that small account sometimes with new strategies and say, okay, you know, I'm gonna pretend I only have $10 in the account and I'm gonna trade the account or trade the new strategy with that. So when you're learning lessons like we were talking about, you learn them small, you take your hit and move on because well, and I have a perfect example. I'm actually implementing the first swing trading strategy that I've ever done without a stop loss.
Michael:And I you know, Dave probably just cried a little bit inside, which means I will be holding stocks overnight without a stop loss. And part of me wants to open up a separate account in Interactive Brokers and put $10 into it and just do that because I've tested it back thirty five years, and it has one large drawdown of, like, thirty percent that was COVID. And the rest of the time, the drawdown is, 10 or fifth. So it it looks like it's amazing. And this is, you can find the videos on my channel, but it's the, I think it's Larry Williams who made this strategy in, the seventies.
Michael:And it's it's an RSI strategy that's still working today. But I I kinda I just I I haven't done it before. So it's like I I'm kinda giving myself that freedom. I just wanna do it with a smaller account and just to keep just to keep the rails on myself so that if another COVID comes along and I get slapped, then I know what's gonna happen. And then scale it up slowly over time and and just, you know, giving myself that freedom to experiment while keeping myself comfortable with what's going on.
Dave:Yeah. I love that you're doing that because, yeah, that goes right against the conventional wisdom of gurus and traders you hear. So yeah. And and I think that's great. I mean, it's great that you're experimenting.
Dave:I think that's a great idea. Yeah. It'll I I think it's that's the path to unlock ways that, you know, you uniquely can trade the markets. And and and, ultimately, that's how you get really good is to to come up with a unique perspective that literally only you trade and and exploit that. And and that's, you know, that that's how you get good.
Dave:That's also traders hear that and are like, wow. Gosh. You know? How can I do something that's completely unique? How am I gonna come up with that idea?
Dave:But it's actually not that hard. It's not nearly as hard as people think. And I've, so I've got a couple examples of this. One is the strategy I was trading that I mentioned gaps, and then looking for a pullback and a tightening range in the first half hour. I am 100% certain that I was the foremost expert on that strategy during that period.
Dave:Because I just knew there was nobody else that had spent as much time looking at this strategy, watching them, like there's just no way. So there's just I was, I think, the preeminent expert on all that. And it wasn't that hard. Like, I I that's just all I thought about for a decade, pretty much. And it's not I I call these I call these strategies that are trading strategies that are hiding in plain sight.
Dave:A lot of traders would look at them and think there's nothing there, But it's not that hard for any trader to come up with a unique set of trades that they make from a given idea. And I see this all the time with traders who use the cruncher. So I have and you've gone through it. There's an AFL course I provide. There's a sample strategy in there, basically an opening range breakout.
Dave:Lots of traders use this as a starting point and they come up with very interesting variations of this strategy that they go live with. And every trader that has, that I work with that has started from this point, they'll come to me and say, Hey, Dave, do think about this variation of it? Nobody's even close to the same set of trades. Like, you know, they're using the same starting point. Every single trader has a unique strategy that they end up with, even with the same starting point.
Dave:So it's not hard to be unique in what you're doing. Yeah. I mean, a lot of people trade the same strategy, but the ones that do better are the ones that have a better process for figuring out which trades to take and which trades to skip. I mean, that's just the the the simple way to look at it. And especially when you have a smaller account, that's something that you can do and you can get good at, and you can become the world's preeminent expert on a certain aspect of the market.
Dave:There's no question about it. And that's something that will pay off now, but it's gonna pay off the rest of your training career. Like you and like like you said, when we when I came to you with this idea for the podcast, I think one of your one of the things you said was, Okay. We'll probably run out of ideas pretty quickly, though. I was like, I don't think so.
Dave:I think there are more ideas that will, I don't think we'll ever get to all the ideas that we have for the topics here. Yeah. I think start, but then also give yourself plenty of rope. Like, it you know, if you set a goal that, okay, next week I gotta have this, you know, I gotta have something live. It's just not going to work.
Dave:It's just, it's another level of pressure. So just give yourself plenty of time. And part of that is, not needing the money and just you have to have faith that you're sort of like we've, on this podcast that, you know, there's this fear. Maybe we'll maybe we'll run out of ideas. Maybe we will, but I don't think that's the case.
Dave:Like, as long as you're, you're thinking about it and you're doing it on a daily basis, you're not going to run out of ideas and you're going to find way more ideas that you can't even imagine that you're going to come up with now. So just give yourself plenty of rope, work on your process more than, you know, staring at your p and l, every day. Yeah. I totally agree. Well, yeah, I think this has been a good good couple episodes.
Dave:And I'm Dave May. Talk to you next week on line your own pockets.
