Finding Your Position Sizing Algorithm

• Posted by derek
• on October 19th, 2010

“Whatever you think your position size should be, cut it at least in half.” Bruce Kovner

Inspired by Chris Perruna’s post “Position Sizing and Expectancy“, I thought it would be a good idea to collect some position sizing archives and share them here.  So much emphasis is placed on selection and entry/exit tactics, when tests have shown that a mediocre selection method with superior position sizing far outpaces the opposite approach.

Consider the components of a trading methodology.  As summarized in “The Original Turtle Trading Rules“, traders have the following to consider when measuring a system or approaching a trade: (HT @ritholtz)

1) What to buy or sell

2) How much to buy or sell

3) When to buy or sell

4) When to get out of a loser

5) When to get out of a winner

6) How to buy or sell

This list is followed with the sentence, “How much to buy or sell is the single most important aspect of trading.”  You can read in detail about the volatility-based position sizing model they used, but keep in mind that we need to find what works for us.  As described by Dr. Van Tharp, there are a ton of factors to consider but sizing models are derived from the following:

1) Fixed share size

2) Fixed dollar amount

3) Percent margin

4) Percent risk(fixed fraction)

5) Percent volatility

Tests show % risk and % volatility to offer the best balance between maximizing profitability and minimizing the risk of ruin. The post from Chris Perruna covered % Risk, here is a recent post from Leigh Drogen covering % Volatility.  A few other sizing articles to consider, covering a range of styles and complexity:

Position Sizing by Trader Mike

Managing Your Money by Gibbons Burke, The Babe Ruth Effect by Michael Mauboussin(ht @covel)

Risk Management by Ed Seykota

On Money Management and Position Sizing by Dr. Van Tharp

As with all trading-based decisions, find what works for you.  Position sizing is not a one-time decision but an ongoing part of every trade…am I most comfortable scaling in, scaling out, pyramiding winners?  Optimal models will not work for you if personal psychology is not convinced, so striking a balance between what looks good in theory and what you can execute without hesitation is the key.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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