Position Sizing—How Much is Enough?

Position Sizing—How Much is Enough?

[vc_row css=”.vc_custom_1548059737073{margin-right: 20px !important;margin-left: 20px !important;}”][vc_column width=”3/4″][vc_column_text]So many traders who trade a new strategy start by immediately risking the full amount. The most frequent reason given is that they don’t want to “miss out” on that big trade or long winning streak that could be just around the corner. The problem is that most traders have a much greater chance of losing than they do of winning while they learn the intricacies of trading the new strategy.[/vc_column_text][vc_separator el_width=”50″][vc_custom_heading text=”Start Small” use_theme_fonts=”yes”][vc_column_text]It’s best to start small (very small) and minimize the “tuition paid” to learn the new strategy. Don’t worry about transactions costs (such as commissions), just worry about learning to trade the strategy and follow the process. Once you’ve proven that you can consistently and profitably trade the strategy over a meaningful period of time (months, not days), you can begin to modify your position sizing strategy to help you take advantage of times when you should either increase or decrease position size. But before you begin to incorporate a strategy with variable position sizing, you should first learn to be thoroughly comfortable with a consistent approach to position sizing. Determining and maintaining a consistent position size is the best way to minimize the effect of the biggest challenge to trading profits that all traders face: a losing streak.[/vc_column_text][vc_separator el_width=”50″][vc_custom_heading text=”Manage Losing Streaks” use_theme_fonts=”yes”][vc_column_text]Once you have a consistent approach to position sizing, it will be useful for you to identify likely losing streaks that your system may generate. All systems generate a losing streak now and then and your position sizing algorithm can help you reduce the position size when your account equity is dropping during a losing streak. You need to have objective and systematic ways of avoiding the “gambler’s fallacy.” The gambler’s fallacy can be paraphrased like this: after a losing streak, the next bet has a better chance of being a winner. If that’s your belief, you’ll be tempted to increase your position size when you shouldn’t.[/vc_column_text][vc_separator el_width=”50″][vc_custom_heading text=”Determining a Losing Streak” use_theme_fonts=”yes”][vc_column_text]One simple way to anticipate the impact of a potential losing streak is to simply understand the statistical probability of your system’s outcome. For example, if your system generates a winning trade about 50% of the time, then you can expect, statistically speaking, to model losing streaks with the probability of a coin flip.

Most people comprehend that flipping heads 8 times in a row is a rare event. One which has less than a 1% chance of occurring. However, what if you were given 200 chances for that event to occur? What would be the probability of getting an 8-in a row losing streak in that circumstance? The answer is roughly about 33%. All of sudden this event doesn’t seem so rare! In fact, consider the following information on streaks in the following table:

Based on this data you can see that it might make sense to use a position-size rule that reduces risk in the event that you have seven losers in a row. Anything more than seven in a row would be an outlier event, and one you would want to protect yourself against. Using the same data, you can see that you would need to plan on experiencing a seven in a row losing streak over the course of 200 trades.

Think of the power of a position-sizing strategy for managing your trading through such a losing streak! If you knew you were going to have a seven-in-a-row losing streak, and you also knew you didn’t want to have much more than a 10 percent drawdown in your trading, then you would realize that you needed to risk less than 1.4 percent of your account on each trade (10 percent drawdown divided by 7 is about 1.4%). By executing this position sizing strategy, and reducing your position size for every loss past seven in a row, you can minimize the impact of a losing streak. That’s trading like a Super Trader!

Warning: strongly resist the urge to meet time-based profit goals by increasing your position size. All too often, traders approach the end of the month or the end of the quarter and say, “I promised myself that I would make “X” dollars by the end of this period. The only way I can make my goal is to double (or triple or worse) my position size. This thought process has led to many huge losses. Stick to your position sizing plan!

We hope this information will help guide you toward a mindset that values capital preservation.

I’ve talked to many folks who have blown up their accounts. I don’t think I’ve heard one person say that he or she took small loss after small loss until the account went down to zero. Without fail, the story of the blown-up account involved inappropriately large position sizes or huge price moves, and sometimes a combination of the two.—D.R.Barton, Jr., Trader, Author, and Market Commentator[/vc_column_text][vc_message message_box_color=”success” icon_fontawesome=”fa fa-quote-left”]I’ve talked to many folks who have blown up their accounts. I don’t think I’ve heard one person say that he or she took small loss after small loss until the account went down to zero. Without fail, the story of the blown-up account involved inappropriately large position sizes or huge price moves, and sometimes a combination of the two.

—D.R.Barton, Jr., Trader, Author, and Market Commentator

[/vc_message][vc_separator el_width=”50″][vc_custom_heading text=”What You Learned in this Course” use_theme_fonts=”yes”][vc_column_text]

  1. How to use your position sizing strategy to preserve your capital.
  2. How important position sizing is to help you meet your trading objectives
  3. Position sizing strategies to help you manage the risk of a losing streak

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