Position Sizing Strategy

Discussion in 'Trading' started by JT47319, Mar 22, 2003.

  1. JT47319


    Taking a cue from the profit taking strategy, I'd like to discuss the optimal position sizing. All of the Dr. Elder books emphasize that position sizing is a much overlooked, but incredibly important part of a daytrader's overall strategy.

    It also seems that putting more than 2% of your equity at risk is guaranteed disaster from which no daytrader can recover from. Now my question is, not only what your particular position sizing strategy is, but what you guys think of an "all or nothing" position?

    Now, before everyone jumps in, the profit taking thread got me to thinking. If the "all or nothing" profit taking method is the one that gets you most profits, what about an "all or nothing" position? But when taking this position, you maintain a HARD stop at most 2% risk?

    Really, there is nothing different from taking four $25K stock positions with a 2% risk tolerance and taking one $100K stock position with a 2% risk tolerance, right? But your ability to take in profits would be greatly increased. Instead of being overly diversified, you have a concentrated position that allows you to gain the most profits.

    And if a trade goes against you, you are either automatically stopped out or you go out on your own. But either way you would maintain disciplined stop management.

    It seems to me that the most profitable daytraders aren't the ones that win 100% of the time, but rather like 50-65% and whose losses are minimal compared to the larger wins. So what do you guys think? Would a diversified position strategy be more beneficial in your opinion? or do you think an all or nothing position, with disciplined stops, could still get you the necessary 50/50 win probability but with huge profits compared to smaller losses?

    Pros? cons? risks? rewards?
  2. A one size fits all definition simply doesnt exist. Elder's books, while better than nothing, are a gross simplification of the mathematics involved. You should get a booklet by Van Tharp called "Special Report on Money Management", which goes into more detail, though it's still relatively skimpy.

    The real answer is that for a given level of risk you can optimize the amount you should risk to an arbitrary degree of confidence (just do Monte Carlo simulations).

    What you will find is that the optimal amount will depend on your result distribution. In other words a person with low win percentage, but high average win should risk a different amount than someone with a high win ratio, but smaller wins. This also will depend on what you max expected loss is.

    For my trading style (based on my historical results), I applied a Monte Carlo simulation and found that I should risk 2.3% of my capital per trade for optimal monthly profits with 95% confidence. In other words, every time I place a trade, I calculate how many contracts I should buy/sell such that the loss on the trade would be 2.3% of capital if my initial stop loss is triggered. If the number of contracts is a fraction, I round it down to the nearest integer.

    For someone with different trading results the optimal trade risk will be different. If you find this interesting pick up a Stat 101 book. This isnt nearly as complicated as it might sound.

    Note: the above discussion is applicable for someone who only holds one position at a time. If you are a multi-position trader, optimizing risk is an order of magnitude more complicated.

  3. It depends on the specific circumstances relating to the directional position... and for spreads, there are a whole different bunch of factors...
  4. What is the rate of growth of the increase in your capitalization as just realted to your cited method and how frequently do you have break points for each given rate of growth are they discretely increase? Just roughly speaking as a reflection over the years.