What is Position Sizing?

Position sizing determines how much money is spent on each position. Beginner traders often ignore position sizing and think stop management is how to manage risk. Expert traders understand that position sizing is key to managing risk.

The simplest and most common position sizing method is to allocate equal amounts of the portfolio to each position. For example, a $100,000 portfolio would put $20,000 into each five stock positions. This is what the High Performing System does: equally sized positions with 100% invested.

Effective position sizing depends on the level of risk the trader wants to take and the reliability of the trading system. Dr. Van Tharp explains the many choices of position sizing and how to develop your own method in his excellent book called Definitive Guide to Position Sizing.

Here is one way you can use position sizing to change the risk of a trading system. For example, if a system has a 30% drawdown and you would prefer only half of the drawdown, you could put on half-sized positions. In the $100,000 example, you would put $10,000 into each position instead of $20,000. Of course, the returns would be reduced too.

Another position sizing method–one of my favorites–is scaling out of a trade. This means that as profits are made, some of the position is closed to realize those profits. I use this method to keep the amount I have at risk in each trade around my target, instead of letting the at-risk amount grow as profits grow. Dr. Tharp explains this in detail in his book. Scaling out smoothes the equity curve by
lowering drawdown. However, sometimes it does not make as much profit as would have been made if scaling out was not done.

Please leave your questions and comments on position sizing by leaving a comment.

Tags: beginner traders, drawdown, FAQ, position sizing

Related Websites

• How to Invest in Stock It is hard to go on the Internet these days without seeing an ad offering exclusive advice for making it big on the stock market,...
• Fixed Annuities and Financial Risk This baby boomer and no doubt many others are giving more consideration to fixed annuities as alternative investment vehicles.  Fear of more market losses and...
• Credit Card Arbitrage Not Worth the Risk Credit card arbitrage is not a new phenomenon, but one that I never really understood until I began writing about personal finances. I started stumbling...
• Learn to Save Money The Book of Proverbs has many great financial principles. The second financial principle we want to look at in our series is 'learning to save...

|  Email This | Share with:

• 
• 
• 
• 
• 
• 
• 
• 
• 
• 
• 
• 
• 
• 
• 
• 
• 
•