I bought Tesla calls a couple of weeks ago.

But this wasn’t an ordinary trade. In fact, I wouldn’t even call it a “trade,” per se.

This was pure speculation. A YOLO move that would test even a hardened gambler's sanity.

Our very own Nick Riso alerted me to the action.

Speculators were betting on far out-of-the-money TSLA calls. The bets (and there were many) were clustering around the $800–$900 strikes.

That’s a far cry from TSLA’s current share price of $400.

Keep in mind, these were weekly calls. They were set to expire in a matter of days, making those $900 calls a true all-or-nothing bet.

The only way it could win big is if Elon Musk announced a major move like a Tesla/SpaceX merger.

These huge bullish positions and the rumor potential were enough to convince me to take my shot.

Just a few days later, the calls I bought expired worthless. The longshot Tesla trade simply didn’t work out.

But everything went exactly as I planned.

You see, I didn’t bet the farm on those TSLA calls. Far from it! I only laid out an infinitesimally small portion of my trading account to take on this high-risk position.

I expected these calls to go to zero. And I was totally prepared for this outcome.

Live to Trade Another Day

The reason I didn’t lose my shirt betting on a TSLA long shot is that I obeyed my position sizing rules.

Traders love to dream about big gains and talk about their favorite setups. But position sizing is by far the single most important trading concept you need to master to become consistently profitable.

You’ve no doubt heard stories of traders going on tilt and blowing up their accounts. Nine times out of 10, this happens because they are taking too much risk on low-probability trades.

The message board degenerates are right — you only live once. So act like it! Protect your capital at all costs. 

Earlier this week, we had a great position sizing discussion over at The Trading Desk. And I wanted to share my complete position sizing rules here with you.

If you’re having trouble consistently growing your account — or even if you just need a quick refresher to help optimize your performance — you’re going to want to study these rules and add them to your trading toolbox.

Before we dive in, I have one quick note…

The rules I’m about to reveal apply to short-term trading, not longer-term investing strategies. I’ll share more about my investment ideas another time.

For now, let’s just concentrate on our trading accounts.

A Comprehensive Guide on Position Sizing

First and foremost, I adhere to a dynamic position sizing strategy. That means my position sizing changes based on market conditions.

Getting smart about position sizing means understanding that different market conditions command different levels of risk.

Depending on how aggressive you are, I recommend risking 1%–3% of your total account value on any given trade. I know some folks with smaller accounts might want to risk more, potentially up to 5%.

Just understand that the higher percentage you are risking per trade, the fewer consecutive losing trades you will need to bust your account. When in doubt, live to trade another day. You want your account to be able to withstand major losing streaks to keep you in the market.

For demonstration purposes, I’m going to call a normal position size you are comfortable with “1.” This is a regular, full position size for a single trade.

Now, let’s explore how this position size should change based on market conditions.

Normal market conditions: In “normal” bull market conditions, your position size should be 1. These are periods where a longer-term uptrend is confirmed, stocks are generally behaving, and breakouts are mostly sticking. This is your default setting. Market conditions aren’t always cut and dry, so it’s fine to default to 1 in most bull market circumstances.

Corrective conditions: Several times per year, stocks will need to chop or go down. These corrective conditions are perfectly normal in a bigger bull market. In these conditions, I try to reduce my position sizing to 0.5. So a half size or less. When the market is in a correction, breakouts are less likely to extend and mean reversion dominates the tape. During these periods, I also take fewer trades to limit my exposure. (Note: I suspect we might be transitioning to more corrective conditions over the next few weeks. I’ll be paying close attention and adjusting my strategies accordingly.)

Goldilocks market: A couple of times per year on average, we will experience near-perfect market conditions. This is when breakouts extend, and most stocks enjoy a rising tide. Overextended stocks continue to run higher. Most of your trades tend to work better than expected. In these conditions, you can trade more often and risk more, maybe 1.5x to 2x your normal position size. Just remember that these conditions won’t last forever. Take advantage when you can! (Note: the recent run in the chips could certainly be classified as an isolated goldilocks market.)

Bear market (meltdown phase): Cash is king. Maybe scalp some downside action here and there, but trade light and sit tight. The key in these periods is to not lose all the profits you made during the previous bull phase.

Bear market (post-meltdown): Trade these conditions with the same rules as “corrective conditions” above. If you’re aggressive, you can take quick swings at counter-trend bull rallies. Just be sure to take profits early and often.

Special situations: Every now and then, you might be lured into a wildly speculative trade, regardless of market conditions. Just as I did with my TSLA calls, these should be incredibly small positions where you understand you will almost certainly lose 100% of your capital on the trade. Understand that these lottery tickets rarely pay out and treat them with care!

Putting It All Together

The main benefit of dynamic position sizing is that you are trading more often and with more size when probabilities are in your favor. Then you’re pulling back and preserving capital when market conditions are less favorable.

If the market experiences a 10% drawdown and you’re able to lose just 2%–3% over this timeframe, you are setting yourself up to greatly outperform any passive investors who are simply sitting tight during these periods.

It might not sound sexy, but losing less is the main component to beating the averages.

Even with subpar trading results that fail to beat the benchmark during normal market conditions, you can still log extreme outperformance by simply limiting your exposure during corrective periods.

Plus, if you’re fully able to take advantage of goldilocks conditions when they arrive, you should have little trouble consistently growing your trading account.