Position Sizing for Consistency!

Hi folks,

Position sizing! I get questions about this topic quite frequently on "X" and from private Art of Trading members, so lets talk about it here, today!

Position sizing is a core fundamental to any trading strategy and can literally be the difference between consistency in the markets over the long run or into the other extreme of outsized drawdowns and the difficulty and stress of trying to trade those losses back if/when a particular strategy goes through a drawdown phase. 

Protecting your capital comes first and foremost! Part of protecting your capital is managing it with responsible position sizing. Your number one rule should be to protect your initial capital at all times, you're in this business because you have money to trade, without it you're simply not in the business of trading!

"Inconsistent and irresponsible position sizing is like swimming in the middle of the ocean without a direction or a way out! Eventually the market will bite back!"

NAVIGATING BLIND

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Lets break down the importance of proper position sizing:

Proper Position Sizing Controls Risk Per Trade!

• If you always risk a fixed percentage of your capital no single loss can wipe you out!

  
  

  For example a short term trader may risk a total of 2% of their account capital per trade where each trade is 25% of their total available capital. The 25% sized position would need to drawdown a total of 8% for the entire account to draw down 2%. This gives the core, full size position enough room to breath without getting needlessly stopped out!

• It limits the damage from losing streaks and keeps you in the game long enough to benefit from your edge.

  
  

  For example lets say you have a $10,000 account and you risk a very conservative 1% per trade. Your total risk for each trade sits at $100. If you incur ten losses in a row it would be a $1,000 draw down, not your entire account! This mentality and method can be scaled larger to say $100,000 or even $1,000,000!

Proper Position Sizing Prevents Emotional Trading!

• Inconsistent sizing leads to emotional traps.

  
  

  Traders often switch the sizing of their positioning larger after a strong win because they're feeling confident about the money they made on the previous trade. Then they take an outsized drawdown on the larger position erasing the previous gains and then some. After this they go smaller because they're "scared" from their previous loss and if this next trade is strong the cycle continues. Sticking to a single fixed position size prevents this emotional trap.

• Oversized positions create stress leading to fear-based exits or revenge trading.

  
  

  Naturally larger position sizes make for more volatile PnL. Watching your PnL change rapidly in short succession pressures the trader into emotion based decision making. After a fear based exit a revenge trade follows in an attempt to make back some of the loss. This can be the single most dangerous cycle a trader can get in the habit of!

Proper Position Sizing Smooths Your Equity Curve!

• A fixed, responsible position size smooths out your equity curve.

  
  

  With a fixed, responsible position size, say for example 25% of your account capital per trade both gains and losses are manageable. No single loss takes the account out helping to create manageable losers. Since the position size is fixed gains and losses remain stable allowing progress to be made in a consistent manner over a long period of time.

What Happens when a trader is irresponsible and inconsistent with position sizing?

• One oversized losing trade can ruin weeks or months of gains.

• Variability in size can distort the effectiveness of gains and losses. Outsized losses and smaller inconsistent gains are a natural cause and effect.

• You’ll likely make more decisions based on emotion than logic.

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How do I build a consistent position sizing strategy that works for me?

Start by defining a loss metric that you're consistently comfortable with. The best and most consistent traders are those who are comfortable with taking losses. They're comfortable with taking losses because those losses are consistently defined. In terms of short term trading a general rule of thumb should be no single trade should draw your total account capital down by more then 2%. This rule can be modified + or - 1%, just define that number.

So what does this mean? How do I come up with position sizing based on a 2% rule?

Think of it this way. If you have a $100,000 account the biggest allowable loss is a $2,000 drawdown in a single trade, but this does not mean you're sizing each one of your trades at $100,000!!! Your defined position size could be $10,000 which would allow a 20% drawdown on a single trade equating to a $2000 loss.

Or

If you wanted to be more aggressive with your sizing but still have a defined fixed loss a $20,000 position size would allow your trades a total drawdown of 10% before you reached your defined single loss limit of $2000.

Personally, I size my trades at around 25% of my total account capital in the Swing Trades (Short Term Trades) portfolio; This is more on the aggressive side of the equation, but it's sustainable. My maximum single loss of total account capital per trade stands at around 2.5%. Giving the 25% sizing per open trade a maximum draw down of -10% before being stopped out. 

I.e. Assume total account capital for the Swing Trades (Short Term Trades) portfolio is $100,000 

Each open full-size position is 25% of capital or $25,000 

I'd be fully invested(without margin) at 4 full-size open positions. (On a side note: I rarely have more than 3 open positions) in the Swing Trades(Short Term Trades) account. 

Ok, Well I'm good at consistently positioning myself in the market in terms of size. Can I build out rules where I have position sizes defined on the volatility of a stock or the market?

Yes! Traders with more experience tend to have these systems in place. It comes from experience and trading many different types of markets over a longer period of time. I tend to like to keep it simple and not overcomplicate things. When I'm trying to position in a more volatile stock or market I will start with a half sized position.

Dynamic sizing also helps with:

• Stocks that have wildly different intraday ranges from one day to the next.

• Positioning into more volatile markets.

  
  

This way you avoid getting stopped out too easily in choppy markets or taking on excessive risk during volatile swings. You're adapting to the market in front of you. Those market conditions need to be defined or else you would be just modifying your position sizing without a defined parameter.

I hope this step by step educational guide helps!

Cheers and Happy Trading!