Let’s talk about position sizing. The people who goad you to go all-in are either full of shit or short-term lucky. I mean this in a mathematical sense.
Everyone talks about only risking 2% per trade, but why 2%? Why not 3% or 30%? I’ll show you why.
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Everyone talks about only risking 2% per trade, but why 2%? Why not 3% or 30%? I’ll show you why.
/thread
Your position sizing strategy has an enormous effect over your returns long term.
Too small, and you’ll never make any money. Positions too large will put you out of the game before you’ve had time to strike it big.
Too small, and you’ll never make any money. Positions too large will put you out of the game before you’ve had time to strike it big.
Also, I assume you know what I mean when I say “risk 2%”, in that I am *not* saying “only put in 2% of your capital”. If that doesn’t make sense read my earlier thread here:
I’m going to share with you a few charts and ideas taken from Adam Grimes’ excellent “Art and Science of Technical Analysis”. (It's really good. You should read it.)
Let’s pick a simplified model: assume every trade wins or loses with equal probability (50% chance you win, 50% chance you lose). When you win, you win 1.2x risked. When you lose, you lose 1x risked.
Let’s take the classic strategy of only risking 2% per trade — e.g. on a $100,000 account, we risk $2,000 per trade. Look at what happens if we take 1,000 trades: 
On average, we end up with $150,000. But how many of these simulated runs went bankrupt? *None*.
This is a key idea: if you run out of capital, you’re out of the game - so don’t take position sizes that will put you out of the game if you’re wrong.
This is a key idea: if you run out of capital, you’re out of the game - so don’t take position sizes that will put you out of the game if you’re wrong.
Here’s a plot of the returns for 50 “traders” in this simulated sample. Again, notice that none drop to zero and most do well (with this strategy).
But what if we re-run the test, risking $3,000, $4,000 or $5,000? What you see in this chart?
First, the simplistic understanding that “the more you risk the more you make” has validity. But there is a cost:
1. We are taking higher risk that is not adequately compensated by higher returns and
2. At the 5% risk level, 2% of traders have gone bankrupt.
1. We are taking higher risk that is not adequately compensated by higher returns and
2. At the 5% risk level, 2% of traders have gone bankrupt.
Let’s say that you’re confident you won’t be the one to go bankrupt. You love the idea of higher risk / higher reward, and you want to go nuts. What do higher risk position sizes look like?
As you increase your position sizes the risks of bankruptcy start to outpace incremental gains. At around 9%-risk-per-trade we have a 15% chance of our accounts going bankrupt. Yikes.
These odds makes sense at higher levels: a $25k bet on a $100k account (risking 1/4th of your capital) gives you only three chances to be wrong before you’re out of the game.
So while you might be egged on to risk a huge amount of your capital per trade, know that you’re also increasing your risk of going bust.
When you make a trade, you can’t really control where your stops should be (that is, use a little TA and the market decides that). But you can control the quantity of units you buy.
So instead of risking a large percentage of your account, pick a percentage you’ll risk (1-3% of your total capital) and scale the number of units you buy accordingly.
