Philosophically, it's harder to manage risk for mean-reversion trades vs trend, because the trade looks more attractive the more it goes against you. If you're short a spread at 1std, you definitely want to be short the spread at 2std, 3std all the way until you get liquidated.
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Max position size is a good static rule. Dynamically, cut position size when a reversion trade goes against you. Can always add back when the spread tightens (reduces profit but prevents blowup) or if it *really* blows out you have preserved capital for a more attractive trade.
Be *very* careful about adding to a losing reversion trade. The fact that you lost money is evidence that your thesis is wrong. Unless there is a cap on how wide a spread can go, this is a good way to blow up.
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What is the relative probability of:
1. This is an unexpectedly juicy convergence trade?
2. My model or understanding of positioning is wrong?
As a spread widens within the expected range, you can probably weigh 1 heavier.
As it starts to really blow out 2 is more likely -
European monetary union interest rate convergence trade
End of conversation
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