Think Position Sizing is Boring? Check This Out!

“My strategy worked well for a while, but then one trade wiped out all my gains.”

Some form of the above statement is probably the most common frustration I see among traders who come to me for help.

When you’re trading a strategy it is incredibly frustrating to have success for a while, but then have it all evaporate in just a day or two.

The most common reaction to this is to blame the strategy and move on to another idea and then the cycle continues.

But in most cases, the strategy is not the problem.

The problem is inconsistent position sizing.

When you don’t have a solid method for deciding how many shares to use for a trade, you end up with a big problem.

You use a relatively small number of shares for the winning trades and a relatively large share size for the losing trades.

You’re almost mathematically guaranteed to end up in the “one trade eventually wiped out all my profits” situation.

A Real Example

I’m getting ready to go live with a new trading strategy and I’m finalizing the rule set using my standard process.

The first thing I do when going from an idea to an actual trading strategy is to determine the best position sizing approach.

Here’s the before and after equity curve for the same set of trades. (image below)

The blue line represents the strategy’s equity curve using a constant number of shares for each trade.

The red line is the same strategy with a thoughtful position sizing approach applied to it.

Same account size, same average money used per trade, you’re just applying a coherent position sizing approach.

You can see the difference!

Imagine trading the strategy using the naive approach of the blue line – you get long periods of frustrating drawdowns.

Yes, you end up with a profit but it’s a wild ride.

Compare that to the smoothness of the red line.

The drawdowns aren’t eliminated, but they’re shallower and shorter.

With this approach, the strategy will be far easier to trade and scale up over time.

It’s not that the strategy is bad, it’s that a poor position-sizing approach turns a perfectly good trading strategy into a loser.

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