Trading with Margin (of error)

 Leverage: it's one of the most alluring and yet dangerous words in the trading dictionary. Synonymous with leverage is the concept of trading on margin. In the "real" (non-trading) world, leverage and having margin are perceived as great things. It means you are in an advantageous position and have built a buffer of protection around something of importance. Well, what if one could introduce leverage and margin in the context of one's trading skill or strategy? The purpose would not be to amplify one's gains, but to amplify one's protection from downside.

I have discussed the idea of eliminating system-level bugs in one's trading, but let's take this to another level. Sure, simply removing negative facets of your trading can transition you from being an unprofitable to profitable trader, but your margin for error may be razor-thin to maintain whatever edge you have. Instead, wouldn't it be nice to actually add additional protection--margin--to that trading system? That would amount to "padding" your edge, or adding more margin for error in case something goes wrong. 

So how does one go about doing this? Well it starts with an examination of the potential bottlenecks or minefields in one's trading, and then actively incorporating counter-measures that not only negate them, but prevent them from ever being a factor. This may involve a bit of creativity as it may involve identify the quirks in your particular trading system and habits and finding ways to protect yourself even on the crappiest of days. One powerful way to protect yourself (that certain prominent traders have advocated) is staunch position sizing (in adherence to Kelly criteria), such that the the risk of ruin goes down drastically. It makes for a more boring trading experience if big daily gains are your thing, but one with much less heartburn. Well thought out, system-level hard rules that are mathematically rooted are usually the best ways to avoid catastrophe. When I say mathematically rooted, it could still apply to what appears to be a subjective measure such as sleep quality, but that correlates very well to your trading performance. For example, never trade with less than 4 hrs of sleep could be a hard rule that saves you from a string of unforced errors that you have seen when not getting enough sleep. I've never been much of a rules person, but ones that clearly save you from disaster, and that can be justified through data, cannot be ignored and can only add to your Trading Margin for error!