Which Sizing Technique; Equal, Reducing or Increasing.
I don't want to get into the theory here, and hence lets work our way directly with Numbers. In each of the cases, we will want to Invest Rs. 500000 in a counter at every 10% positive move. The counter is of Rs 60 currently and we keep adding quantities till it appreciates by 40%, that is it moves from 60 to 84. On ever 10% rise in the price from 60, we will add positions on 60, 66, 72, 78 and 84. In the end, we will sell everything at 120, that is a 100% gain.
Reducing
Under this, the initial Bet size is the biggest and then we keep reducing in some proportion. In our case, in this sizing method, we invest 140000, 120000, 100000, 80000 and 60000 respectively at each level. The starting amount is 500000 and the ending amount is 873639. This gives us gain of 75%.
Equal Size
Under this, equal size is bet on every 10% move. That is, 100000 is invested at every step. The initial capital of 500000 grows to 845188. This gives a gain of 69%.
Increasing Size
Under this, our first bet is the lowest and last the highest. We invest 60000, 80000, 100000, 120000 and 140000 at every 10% move. The starting capital is 500000 and the ending capital grows to 816736. This gives us gain of 63%.
We can see clearly that the best result is in Reducing the bet size and the worst result is by Increasing the bet size. However, this is one side of the story. We are only looking at the Gains. What if, we enter an investment with a SL of 10% and for each of the techniques, the SL gets triggered. How would the picture look now?
Well, for this, we will be using the gross gain of each technique and will divide it by the one time 10% loss on each technique. In the end we will take absolute value of the same to arrive at profit factor. An accurate measure of profit factor would only come on series of trades, but here with one trade on three different techniques, we can get a rough idea.
On 10% stop loss for every technique on initial bet quantity, the losses are Rs 14,000 , 10,000 and Rs 6,000 for Reducing, Equal and Increasing bet sizing technique. This means, Reducing technique would be resulting in Maximum gains, but maximum loss. Whereas, Increasing technique would be resulting in Minimum Gain and Minimum losses. Increasing technique would have the best profit factor based on this example and Reducing technique would have the worst. Hence what do we do now?
Now it comes down to personal choice. I trade with Equal bets and I just like the trade off between what this technique has to offer in Profits and what it has to take in Losses. I prefer not to be on the extremes. On a broader note though, I can suggest one position sizing framework for those who are more adventurous.
High Volatility Environment - Either use Increasing technique or Equal Technique. Do not use Reducing technique here.
Low Volatility Environment - Either use Reducing technique or Equal Technique. Do not use Increasing technique here.
When Volatility is high, draw downs and losses are more, hence use conservative techniques. When volatility is low, draw downs and losses are relatively less and hence use aggressive techniques. I can hope some of you have now guessed why I use the equal sizing technique. If not, then the answer lies in the fact that it features in both the volatile and non volatile environment.
P.S - Excel sheet of this example is attached.
Tc
