Position Sizing Strategy

[swingtrader]

Hello Everyone,

Now that the market is in a short term downtrend and stock tip threads have mostly disappeared I think it is a good time to discuss what is really important in trading - Position Sizing / Money Management Strategies. I Would like to hear/discuss the different sorts of position sizing strategies experienced traders here use for stock trading.

For new traders:

"Position Sizing" is the way you determine the number of shares of a stock you would buy when you decide to initiate a trade (and also how many shares you would continue to hold throughout the duration of the trade). It also decides how much equity will be allocated to a single position. Position Sizing is used by everyone even though they might not think about it (usually traders just buy 100 or 50 shares or any number that they are comfortable with or can afford). But good position sizing is what makes or breaks a trader, it is the strategy that keeps a trader in the business longer. It turns a mediocre trading system into an excellent one (but won't help a losing system).

The most popular/recommended position sizing strategy is to risk not more than 2% on any single position.

New traders - make sure you go thru' previous threads in "Risk & Money Management" section of this forum, there are good posts on risk & money mgmt by Traderji & CreditViolet.

Books on position sizing:

Trade Your Way To Financial Freedom by Dr. Van Tharp
Portfolio Management Formulas by Ralph Vince
The Mathematics of Money Management by Ralph Vince
The Trading Game by Ryan Jones

My Strategy:

I use a combination of percent risk & percent volatility strategy. Here are the rules I use:

- My main aim is to ensure that I stay in the business longer so my trading system gets a fair chance to realise its potential.
- No position should be greater than 10% of my total trading equity
- I don't risk more than 1% of my total trading equity on any single position
- I make sure my positions are "volatility balanced". In other words I make sure that all my positions fluctuate approximately the same each day in the market. I do this using Average True Range of the stock.

Example:

Say I am planning to buy HINDLEVER, here is what I would do to determine the number of shares I would buy:

Total Equity : 100,000.00
Max Equity for each trade : 10,000.00 (10% of total equity)
Risk Amount : 1,000.00 (1% of total equity)
Volatility Amount : 500.00 (0.5% of total equity. This is the fluctuation level per day per position)

Average True Range (10 Day Avg) : 5.63
Last Market Closing Price : 173.20 (For simplicity assume this is the entry price)
Stop Loss at : 163.40 (Will get out just below previous reaction low)

Number of shares to buy (percent risk model) = Risk Amount / (Entry Price - Stop Loss Price)
Number of shares to buy (percent risk model) = 1000 / (173.20 - 163.40)
Number of shares to buy (percent risk model) = 102 Shares

Number of shares to buy (percent volatility model) = Volatility Amount / Average True Range (10 Day)
Number of shares to buy (percent volatility model) = 500 / 5.63
Number of shares to buy (percent volatility model) = 88 shares

Number of shares to buy (based on Max Equity for each trade) = Max Equity for each trade / Last Market Closing Price
Number of shares to buy (based on Max Equity for each trade) = 10000 / 173.20
Number of shares to buy (based on Max Equity for each trade) = 57 shares

I will buy minimum number of shares determined from the above three models. So in the above case I would buy 57 shares.

So here is what I basically do. I am still trying to fine tune these things. The above parameters used are what I am currently using but I am in the process of doing trial & error to come up with parameters that fit me well. I would now like to hear what the experienced traders here do.

--SwingTrader

 

[srisara]

SwingTrader,

very nice post and a very good strategy. I would like to ask one question. If you fixed your Trading Capital @ 1 lac. What if, if the Trading Capital is a Variable.

By that what i mean is, someone trying to build up a portofolio. If he keeps on adding say 20,000 per month say from his salary into trading, then his Trading Capital is going to go up slowly.

Also, what about the End-Of-Year profits to be pumped into trading again?

I feel, if you are adding a position, and if position starts to trends, you can further add more of it to average down. Quit the excess shares, when the your traget or above it reaches, having kept minimum of shares?

I am planning to try this techinque, slowly as a long term investment.
Satya

 

[swingtrader]

SwingTrader,

very nice post and a very good strategy. I would like to ask one question. If you fixed your Trading Capital @ 1 lac. What if, if the Trading Capital is a Variable.

By that what i mean is, someone trying to build up a portofolio. If he keeps on adding say 20,000 per month say from his salary into trading, then his Trading Capital is going to go up slowly.

Also, what about the End-Of-Year profits to be pumped into trading again?

I feel, if you are adding a position, and if position starts to trends, you can further add more of it to average down. Quit the excess shares, when the your traget or above it reaches, having kept minimum of shares?

I am planning to try this techinque, slowly as a long term investment.
Satya

Satya,

I have not fixed my trading capital at 100000, the amount is just an example. The percentages shown are computed using the current total equity in the account. So if you add more money or your trading capital increases due to profits, next time you trade you will automatically compute the risk amt etc using the new total equity.

As for your other questions, I am still experimenting with various things like scaling into a position etc. Not much to comment on it at this point.

--SwingTrader

 

[srisara]

very true..... thanks for clearning doubts.

 

[Saint]

Hello Everyone,

Now that the market is in a short term downtrend and stock tip threads have mostly disappeared I think it is a good time to discuss what is really important in trading - Position Sizing / Money Management Strategies. I Would like to hear/discuss the different sorts of position sizing strategies experienced traders here use for stock trading.

For new traders:

"Position Sizing" is the way you determine the number of shares of a stock you would buy when you decide to initiate a trade (and also how many shares you would continue to hold throughout the duration of the trade). It also decides how much equity will be allocated to a single position. Position Sizing is used by everyone even though they might not think about it (usually traders just buy 100 or 50 shares or any number that they are comfortable with or can afford). But good position sizing is what makes or breaks a trader, it is the strategy that keeps a trader in the business longer. It turns a mediocre trading system into an excellent one (but won't help a losing system).

The most popular/recommended position sizing strategy is to risk not more than 2% on any single position.

New traders - make sure you go thru' previous threads in "Risk & Money Management" section of this forum, there are good posts on risk & money mgmt by Traderji & CreditViolet.

Books on position sizing:

Trade Your Way To Financial Freedom by Dr. Van Tharp
Portfolio Management Formulas by Ralph Vince
The Mathematics of Money Management by Ralph Vince
The Trading Game by Ryan Jones

My Strategy:

I use a combination of percent risk & percent volatility strategy. Here are the rules I use:

- My main aim is to ensure that I stay in the business longer so my trading system gets a fair chance to realise its potential.
- No position should be greater than 10% of my total trading equity
- I don't risk more than 1% of my total trading equity on any single position
- I make sure my positions are "volatility balanced". In other words I make sure that all my positions fluctuate approximately the same each day in the market. I do this using Average True Range of the stock.

Example:

Say I am planning to buy HINDLEVER, here is what I would do to determine the number of shares I would buy:

Total Equity : 100,000.00
Max Equity for each trade : 10,000.00 (10% of total equity)
Risk Amount : 1,000.00 (1% of total equity)
Volatility Amount : 500.00 (0.5% of total equity. This is the fluctuation level per day per position)

Average True Range (10 Day Avg) : 5.63
Last Market Closing Price : 173.20 (For simplicity assume this is the entry price)
Stop Loss at : 163.40 (Will get out just below previous reaction low)

Number of shares to buy (percent risk model) = Risk Amount / (Entry Price - Stop Loss Price)
Number of shares to buy (percent risk model) = 1000 / (173.20 - 163.40)
Number of shares to buy (percent risk model) = 102 Shares

Number of shares to buy (percent volatility model) = Volatility Amount / Average True Range (10 Day)
Number of shares to buy (percent volatility model) = 500 / 5.63
Number of shares to buy (percent volatility model) = 88 shares

Number of shares to buy (based on Max Equity for each trade) = Max Equity for each trade / Last Market Closing Price
Number of shares to buy (based on Max Equity for each trade) = 10000 / 173.20
Number of shares to buy (based on Max Equity for each trade) = 57 shares

I will buy minimum number of shares determined from the above three models. So in the above case I would buy 57 shares.

So here is what I basically do. I am still trying to fine tune these things. The above parameters used are what I am currently using but I am in the process of doing trial & error to come up with parameters that fit me well. I would now like to hear what the experienced traders here do.

--SwingTrader

Hi SwingTrader,

Great stuff.......risk management is everything.Nice........and keep the education coming!

All the best!
Saint

 

[phoenix]

Excellent write-up,Swing Trader!

Phoenix

 

[nautilus]

Hello Everyone,


So here is what I basically do. I am still trying to fine tune these things. The above parameters used are what I am currently using but I am in the process of doing trial & error to come up with parameters that fit me well. I would now like to hear what the experienced traders here do.

--SwingTrader

SwingTrader Hi:

Excellent writeup. Although I trade in leveraged markets I use similar position sizing strategies along with probability studies on price patterns and r/r that I have done over the past many years.

When the probabilities and r/r are in my favour I become a bit of a bully and increase my exposure to the market - if they are nominal than I become a coward and reduce my exposure!

As I trade in leveraged markets I allow a maximum of 2% risk per trade of the underlying capital, and would not expose more than 10% of my capital to one single trade. In addition I would stop trading for the month if I lose more than 3% of my capital in a month.

I also wait for a trade which would offer me a minimum r/r of 1:2 and a high positive mathematical expectancy of the outcome.

I also make sure that the possible maximum number of positions (diversification) I carry would never exceed 8. My brain is just not capable of monitoring more than these numbers of open positions! In addition studies done by NY Institute of Finance on risk diversification have indicated that the returns tend to climb as we start to diversify and trade multiple items - then the returns tend to flatten out between 8 to 14 and then they start to fall!

Regards

Nautilus

 

[swingtrader]

Thanks, Nautilus. Greatly appreciate your insights. Could you please elaborate on the "probability studies on price patterns"? Are these related to statistics or based on your own trading stats? If based on statistics, can you please point me to any resources on this? I am currently trying to brush up my statistics and do some exercises to identify meaningful price patterns based on the methods detailed in the book titled "The Mathematics of Technical Analysis by Clifford Sherry".

Thanks.

--SwingTrader

 

[phoenix]

I also make sure that the possible maximum number of positions (diversification) I carry would never exceed 8. My brain is just not capable of monitoring more than these numbers of open positions! In addition studies done by NY Institute of Finance on risk diversification have indicated that the returns tend to climb as we start to diversify and trade multiple items - then the returns tend to flatten out between 8 to 14 and then they start to fall!

Regards

Nautilus

Hi Nautilus,

Interesting stat that.I trade in leveraged markets as well and usually traded huge no. contracts on each position,but I have realised over time that the max no of positions I can take is 4......although I tend to pill up on each position.When I go more than 4,insanity sets in,returns fall instead of rising..........I suppose different people have different tolerance levels.But interesting stat though by the NYI of Finance.

Phoenix

 

[nautilus]

Thanks, Nautilus. Greatly appreciate your insights. Could you please elaborate on the "probability studies on price patterns"? Are these related to statistics or based on your own trading stats? If based on statistics, can you please point me to any resources on this? I am currently trying to brush up my statistics and do some exercises to identify meaningful price patterns based on the methods detailed in the book titled "The Mathematics of Technical Analysis by Clifford Sherry".

Thanks.

--SwingTrader

Hi SwingTrader:

The probability studies I talk about are based on personal observations of price patterns over the many years in the market. It has mostly involved grunt work and data sifting (daily and intraday) involving perhaps more than 20,000 years of data of mainly liquid mature markets. The result has been that a series of patterns that occur on a reasonably regular frequency in markets. The probabilities are based on the eventual outcome and resolution of these pattern data samples.

Key Reversal

Just to give you a very simple example Key Reversal is considered very signficant pattern by many traders and market participants. But very few participants understand the significance and the power of this pattern in terms of probabilities. Let me explain:

Key Reversal is formed (top pattern) in a rising market when:

1) the market opens above the high of the previous day and in the process makes a significant new high. (there are other interpretations too!)
2) then the market starts moving lower during the entire trading session and breaks the low of the previous day.
3) the point at which the new bar breaks below the low of the previous day's low becomes a very significant point (statistically speaking/ or probability wise) - because if you now sell the market and put your stop-loss just above the high for the current trading day (the new high) - then the chances of that stop-loss being taken out during the current trading session is less than 5%!
4) the reason for this awesome probability is quite simple - in that the market having just made a new low would now have to climb all the way up and make a new high again to take out your stop-loss.

This is just an example involving a simple two bar structure and their realtionship with one another.

In your search I would suggest go via the "Japanese candle sticks" route as found in standard books - you would find the probability results enlightening and profitable - or for that matter any other book that you find interesting. Most books and authors leave this side of teaching out - which I guess is good for people like you and me who are prepared to invest some time and effort in this direction!

Regards

nautilus