In yesterday’s lesson we introduced another important yet often overlooked aspect of trading and money management strategies which is position sizing. In today’s lesson we are going to begin to look at some of the strategies that many successful traders use to determine their position sizes.

As we discussed briefly in the last lesson many traders make the mistake of choosing an arbitrary number such as 1 contract or 100 shares of stock to trade when they first enter the market. In addition to the fact that this does not consider the amount of capital a trader has at his disposal, it also does not take into account the fact that the Dollar value as well as the volatility characteristics of one contract or 100 shares of stock is going to vary greatly. Like a poker player who bets the same amount on every hand, this also does not allow a trader the flexibility to trade bigger on trades with a higher probability of success and smaller on trades with a lower probability of success.

As you can see from the picture below, a trader trading 100 shares of a $20 stock which fluctuates 5% a day and a second position of 100 shares of a $30 stock which fluctuates 1% a day does not present the risk/reward picture that many traders would expect it would. In this example the smaller position actually has a greater potential risk and reward because of the greater volatility of the first stock in the example.


The next level of sophistication up from the above, is trading a standard trade size such as 1 contract or 100 shares of stock for every fixed amount of money.


As Dr. Van K. Tharp points out however in his book Trade Your Way to Financial Freedom, there are several distinct disadvantages to using this method which are:

1. Not all Investments are Alike (100 shares of a $10 stock which moves 5% a day is not going to be the same as trading 100 Shares of a $10 stock that moves 1% a day)
2. It does not allow you to increase your exposure rapidly with small amounts of money
3. You will always take a position even when the risk is too high.

As you can hopefully see from the above information, while the fixed position size per dollar amount is better than simply picking a number out of thin air, there are many disadvantages to this method. In tomorrow’s lesson we will begin to look at some different ways of overcoming these disadvantages starting with a discussion of the martingale and anti martingale position sizing strategies so we hope to see you in that lesson.

As always if you have any questions or comments please feel free to leave them in the comments section below so we can all learn to trade together, and good luck with your trading.

Hi Dave, i really have enjoyed your course work that you have put together - i am new at trading and i have to say that you have the best "no hype" courses on the net - thanks

I had a question regarding the second half of the lesson on "Fixed Position Sizing: Avoid This Common Trading Mistake"

I just didn't grasp the concept you were trying to convey - starting with the sentence "The next level of sophistication up from the above, is trading a standard trade size such as 1 contract or 100 shares of stock for every fixed amount of money." - then it is stated "Trader starts with $10,000 - Trades one contract until he reaches $10,000, then begins to trade 2 contracts"

What do you mean by the "next level of sophistication" and that there are several distince disadvantages to using this method

Sorry to bug you with this question

Tatters

Hey Tatters,

Glad to hear from you and thank you for the compliment I am glad you like the course.

What I am trying to convey here is that some traders trade a fixed position size, and then increase that position size in proportion to the size of their account.

So the example I give here is that a trader trades 1 contract for every $10,000 he or she has in their account. So for example if the trader has 10,000 then they trade 1 contract and if they have 20,000 then they trade 2 contracts.

The disadvantages that I talk about of this method are as follows:

1. Not all Investments are Alike (100 shares of a $10 stock which moves 5% a day is not going to be the same as trading 100 Shares of a $10 stock that moves 1% a day)
2. It does not allow you to increase your exposure rapidly with small amounts of money
3. You will always take a position even when the risk is too high.

Hope that helps. If there are any other questions or comments as you go through the lessons please feel free to post.

Best Regards,
Dave

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.