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The recovery in stocks over the past month has been extraordinary. It’s one of the sharpest rebounds I’ve witnessed in my 40-year career.

Only last month, markets were in freefall after Liberation Day tariffs were announced. But by late last week, the major indexes were pushing back toward their all-time highs.

As of Friday’s close, the S&P 500 had rallied around 23% off the April low, and the Nasdaq was up around 30%.

That had some folks piling back into stocks, thinking it’s back to business as usual. Some are placing outsized bets on the market rallying further.

That might be a risky proposition given sinking consumer sentiment. On Friday, the University of Michigan survey contracted for a fifth straight month. Yet that’s not the only risk that investors face.

And that’s what I’d like to discuss today…

Recouping Losses

When traders go through a rough patch, they can become impatient trying to get things back on track. And that can lead to all kinds of mistakes…

One is to overtrade. If you’re chasing lots of low-probability moves, the odds are against you. However, it can be just as damaging to allocate too much capital to your trades.

By doubling or tripling the size of a trade, you might think you’ll get their money back faster. But that rarely plays out well…

Instead, it can set off a dangerous downward spiral.

As I learned in the trading pits of the Chicago Board Options Exchange all those years ago, you need to start trimming the size of your trades during a rough patch. Otherwise, losses can knock you out of the game.

If I went through a losing period, I’d cut the size of my trades in half. And if my losing streak continued, I’d halve them again.

If I still hadn’t turned things around, I’d exit all my trades and clear my head. Then I’d come in fresh the following day, ready to start over again.

This allowed me to reset. It also prevented a run of losses from tearing a hole right through my account.

Put simply, when things weren’t going to plan, I scaled down the amount I was prepared to risk on any trade.

But the opposite also applies…

Scaling Up

After a winning streak, I was prepared to up the amount I risked on a trade.

In effect, I was using my profits to trade bigger positions and drive higher returns.

For example, if I had been trading five options contracts, I might increase that to six or seven contracts. That’s how I snowballed my account.

The same logic applies when trading stocks…

Say your strategy allows you to risk 3% of your trading account on a trade. If your account keeps growing, that 3% equates to an ever-growing dollar amount.

In this way, you can really build up your trading account as your profits roll in.

Although it might seem like a simple concept, a lot of traders don’t use scaling. But I think that’s a big mistake. It’s why things can often go wrong.

You’ll be a step ahead if you reduce your positions when things are going against you… and ramp up your positions when things are going your way. That will reduce the stress of trading since you’ll stay comfortable with the amount you’re risking.

And it should greatly enhance your trading results too…

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

P.S. Are we due for a 10% fall?

That’s one of the topics that came up in yesterday’s Trading With Larry Live. You can watch the recording here: https://youtu.be/Rgy-pN218ms?si=c6WOsnaLO9lls6mm

And then tune in just a few minutes from now (at 8:30 a.m. ET) at tradingwithlarry.com for today’s premarket podcast…