17/04/2014
“Endurance is one of the most difficult disciplines, but it is to the one who endures that the final victory comes.”
~Buddha
Most traders spend a lot of time on developing their entry and exit strategies, but very little time on the size of their trading positions. So while wins and losses do matter, how big your trading position is when you win or lose will have a direct effect on your bottom line.
Trading systems are subject to both winning and losing streaks. The assumption a trader should make when trading is that after a winning trade, a winning streak may develop, but conversely after a losing trade, a losing streak may be in the offing.
To take advantage of the streaky nature of a trading system, the trader must consider a strategy whereby he increases his size during winning streaks, but decreases his size during losing streaks.iStock_000017629416_ExtraSmall
When building a trading strategy, and studying the back-tested results, the trader must be aware of his trading statistics. Among the many statistics produced, consecutive wins and consecutive losses are most important.
Too often a trader will try to catch the “big winner” while having on big size. Since no one can really predict the “big winner”, a trader may get caught with a big size on during a losing streak. Taking on a position that is too big during a losing streaks means you will eventually have to catch huge winning trades with similar size in order to make up the loss. Therefore it is better to have a position sizing equation to take advantage of the streaky nature of your system and the unpredictability of the size of the market swings.
One method to consider is sizing positions according to a percentage of your trading account. For example, a trader may consider risking 1% of his account on a position. This is the money management portion of his trading system. This has nothing to do with the trading system itself.
After determining what 1% of his account value is, a trader then divides the risk of the trade into the percentage risk of his account to get his position size. For example, if 1% of your account is $1000 and the risk on the trade is $4.00, then the size of the position will be 250 shares.
During a winning streak the size of the account will increase and so will the dollar risk of the trade, but it will still be set at 1% of the account size. If 1% of your account increases to $1500 and the risk on the trade stays at $4.00, the position size will increase to 375 shares.
If the trader should experience a losing streak and his account decreases in value, then 1% of his account size may fall to $750. If risk stays at $4.00, then the size of the position will be decreased to 187 shares.iStock_000008799731_ExtraSmall
This is only one sizing methodology. There are others and all should be applied to your trading system to find the proper fit. The idea behind this tactic is to take advantage of winning streaks by increasing size and to prevent a massive draw down in your trading account during losing streaks.
Traders should note that this style of sizing will only work if your system has a positive expectancy. In other words, if the trading system is good, position sizing will matter to the bottom line. If the trading system is bad, then proper sizing will not save it.
