Tag Archives: Sizing

General Forex

Trading System Position Sizing

Position sizing is determining HOW MANY contracts to trade when a trading system gets a signal. It is one of the most powerful and least understood concepts with many traders. Its purpose is to manage risk, enhance returns and improve robustness through market normalization. Position sizing can end up being more significant than where a trader buys or sells! Most trading systems and testing platforms either ignore position sizing, or use it illogically.

A big problem with many trading systems is that they risk too much of a traders equity on any given trade. Most professionals agree that traders should never risk more than 1% to 3% of their equity on any given trade. This also applies to the risk for each sector. For example, if a trader is risking 2% a trade in highly correlated markets like 2yr bonds, 5yr bonds, 10yr bonds and 30yr bonds, this is essentially like risking 8% in the same trade. Overtrading this way can produce incredible looking results with returns of 100% or more, but this is usually just a case of using too much leverage and taking too large a percentage risk on each trade (or sector) and or “cherry picking” the best starting date (like right before a series of winning trades).

When running a “Worse Case Analysis” at those high-risk levels, it becomes clear that the risk of ruin climbs dangerously high. A series of losing trades or starting on the wrong day could cause an investor to lose it all (or have an enormous drawdown).

The bottom line is that when putting on a trade, traders should know what percentage of their equity they will lose if they are wrong. This should only be a small portion of their available trading capital. This also means they need to know their risk when entering a trade. Some trading systems like moving average systems do not know how much risk they are taking. This is because the trading system does not know how far the market needs to move to trigger an exit. We think it is dangerous to trade this way and do not recommend it.

Another large problem is the lack of market normalization (such as a single contract based result). For example, we do not think it is logical to trade one contract of natural gas with an average daily volatility of around $2,000 for every one Eurodollar contract with an average daily volatility of around $150. Doing this would mean that natural gas is a more significant market than the Eurodollar. If Eurodollars trend, we want to give them just as much weight as natural gas (or any other market). In the previous example, traders could just simply remove the Eurodollar from the equation and get nearly the same performance. In essence, the results are unintentionally biased (curve fit) to natural gas. An average $150 winning trade in the Eurodollar is not going to offset an average $2000 losing trade in natural gas!

We recommend trading a basket of commodities for diversification, however, if traders do not normalize the data and most of the profits and losses arise from a few of the markets in the portfolio then that is not diversification. The problem is that going forward; traders are going to be dependent on those few markets to perform. It is far better knowing that any market has the potential to perform at an equal level rather than being dependent on markets in that portfolio.

It is likely that most trading systems ignore position sizing, or use it illogically because the design of most software packages is to work with a single contract based test. Of the numerous back testing products available for sale, we are only aware of two software packages that can properly do position sizing and money management testing. There are many products that claim to do it, but we have found that almost all these products do not do position sizing & money management correctly (there are many reasons for this, contact us for details). We use Bob Spears state-of-the-art testing software Mechanica (which sells for $25,000 a copy) for most position sizing based research and testing.

Other problems include vendors that only report the smaller drawdown numbers like “closed trade” drawdowns or “average annual” drawdowns. There are also problems with position sizing concepts such as “Optimal F” or “Fixed Ratio”. We feel both of these are just a dangerous form of hindsight biased curve fitting.

Another common fallacy says that traders should find their “best” single contract based trading system FIRST and THEN apply position sizing to it. This is not the correct approach; position sizing can change the risk-to-reward profiles of a single contract based trading system. A trading system that looked terrific, with a smooth equity curve on one contract basis, can look far less attractive when all markets are equally weighted for robustness.

For all the reason cited above, we develop trading systems with proper position sizing logic. We believe this raises the robustness and significance of the testing results. This also helps avoid the inadvertent optimizing that can occur with other types of position sizing / money management based testing software.

General Investing

Position Sizing

When building a futures trading system one of the most crucial aspects is how it will determine its position sizing. Specifically, how it will determine how many contracts to trade once it gets a buy or sell signal.

One of the best ways to do position sizing is through a formula designed to “normalize” the markets for volatility. This way, a market with high volatility trades much more cautiously than a market with low volatility. In other words, the high-volatility market trades with fewer contracts than a low-volatility market.

The next consideration is how much of the account to risk for each trade. As a rule of thumb, it is best to risk no more than about 1% to 3% of the account size for each trade. So, a $100,000 account should never risk more than about $1,000 to $3,000 for each trade.

Once a trader has determined the risk for each trade and the market’s volatility they can then calculate the contracts to trade with this formula: (account size * risk a trade / market volatility).

Another consideration is the risk for each sector. Traders should never risk more than about 5% of the account at one time in a given sector. So, the risk in highly correlated positions like crude oil, heating oil and gasoline should be summed together. It is this combined risk in a correlated sector that should not exceed about 5% of the account size. Violating this rule can cause traders to be too dependent on one sector and voids the benefits of diversification.

Besides risk for each trade and risk for each sector one should consider the total risk at any given time. This is the amount one would lose if every single trade they were in exited simultaneously at a loss. This amount should not exceed about 10%.

By managing risk, and carrying out position sizing this way, one can substantially cut the risk in trading. Finding trading software that can compute all these position sizing rules is extremely difficult. As far as we know there are only two software packages that can do this correctly. One is Mechanica and the other is Trading Blox.

This article directory limits us on the size of the article we can publish. So, traders wanting to learn more should visit DH Trading Systems website.Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future performance.Traders wanting to learn more about position sizing from award winning futures trading system developer Dean Hoffman should click on the links above.

Forex Trading Articles

Position Sizing at Forex

Those who are new to this forex trading platform for them it is very difficult to resist from being engulfed by the attractiveness of the earning maximum profits in the market.

Even though all the traders are aware of the fact that forex is a risky zone where market is full of frequent up and downs thy used to do common mistakes and then pay huge fine as a compensation for that mistake.

Caution and attention are the keys to come over the hovering ship of the forex currency pair exchange deals and to make position at the market intelligently without occurrence of any big issues.

The formula that can be used to determine the position size to imprint your presence in the market is as follows:

X = R x B/ T x (P1- P2)

Where

X = position size in units of base currency
R = percentage of account trader wish to put on risk
B = Account Balance
T = short and long indicator, -1 in case short position and +1 in case of long position
P1 = Entry Price
P2 = Exit price or stop loss price level

This will help the traders or investors to take active participate in the forex trading platform with the accurate calculation of the exact position size.

Any kind of trading set up no matter it is best in acknowledging trade activities with perfection but still thee are possibilities that any thing can go against your trade position and your winning move can turn up into loss.

Certain degree of randomness or risk always exist in the forex trading platform it is not a big issue to panic but of course precautions should be taken avoid huge amount of losses by implementing good trading practice with preciseness in your trade moves.

When something can not be avoided then we should try to manage such inevitable incidences or occurrence. This is just a part of forex and all the traders should learn to bear the losses if they want to succeed.
Determining the position size would be helpful but important is building your trading psychology to cope with any kind of trading troubles.

Market Analysis

Risk Control Method no-2 Proper Account Sizing in stock market

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Drawdowns are the bane of futures traders. When you are making money in stock market, everything is fine. It is when losses start to mount that doubt creeps. The longer a drawdown lasts and the deeper it cuts into your equity the more painful it becomes. A trader starts to think “I wonder when I’ll get back to a new equity high in stock market,, or even if I’ll get back up to a new equity high.” It’s like inadvertently getting on the down elevator in a sky rise; you don’t know how long it will be before you get back to the floor you were just on. Drawdowns are never easy to deal with. However, if you experience a drawdown that is within the realm of what you had expected going in, it is a far different situation to deal with emotionally than if you figured you would never experience anything worse than a 15% drawdown and now you are 30% in the hole. Or even worse, if you really had no idea what to expect in terms of drawdowns in stock market when you started out, and you suddenly find yourself deep in the hole in stock market. Under such circumstances it can become almost impossible to maintain confidence in your approach.

Following the steps in Section Two can give you some idea as to what you can realistically expect from your trading approach, both in terms of profitability and drawdown as a percentage of your trading capital. By properly sizing your trading account you take an important step toward minimizing your risk even before you make the first trade in stock market.