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Position sizing is an attempt to compute the optimum number of securities
to buy or sell in a particular trade in a particular system. "Optimum"
being the position that maximizes overall return, without exposing the
trader to too much risk. Most use intuition (that's the polite way of
saying 'guess') and it is often their downfall, while others use the rules of
thumb or some mathematical process.
A specific example is the old saw that says, risk no more than 2% of
your capital on any single trade. This is just an example, not my
recommendation. Let's say the biggest loss a particular system
generated during testing was $10 per share. If a trader chooses to risk
2% on every trade using this system, a $50,000 account would
suggest the trader buy or short ($50,000 x 2% / $10) 100 shares in
the first trade. Assume the first trade yielded a profit of $1,500 and
the account now stood at $51,500. The second trade would be
($51,500 x 2% / $10) 103 shares. Now let's say that trade resulted in
a $1,030 loss and the account was left standing at $50,470. The third
trade would be ($50,470 x 2% / $10) 101 shares. Odd lots,
obviously, will cause higher transaction costs and there is no guarantee
that the $10 largest loss in the past will necessarily be the largest loss
in the future.
Ralph Vince has three books, now, I think. His first was Portfolio
Management Formulas. His second, The Mathematics of Money
Management, summarized in about 60 pages the material in his first
book and then expanded into several other areas, some of which made
my head hurt. I have not read his third book. I would certainly
recommend at least the first two, but none are for the mathematically
challenged. In addition to Van Tharp's book, another that comes to
mind is Ryan Jones' "The Trading Game." Personally, I didn't like
Ryan Jones' book, but others swear by it.
----- Original Message -----
From: "neo" <neo1@xxxxxxxxx>
To: <metastock@xxxxxxxxxxxxx>
Sent: Sunday, August 12, 2001 4:07 AM
Subject: RE: money management
> Glen
>
> I have read Van Tharp's book. He does discuss position sizing but as I
> recall it was in general. How specifically does one use position sizing?
> Does Ralph Vince have a book on this that you recommend?
>
> Thanks, neo
>
>
>
> ~ -----Original Message-----
> ~ From: owner-metastock@xxxxxxxxxxxxx
> ~ [mailto:owner-metastock@xxxxxxxxxxxxx]On Behalf Of Glen Wallace
> ~ Sent: Saturday, August 11, 2001 12:05 PM
> ~ To: MetaStock listserver
> ~ Subject: Re: money management
> ~
> ~ I see money management, or bet sizing, as addressing both risk
> ~ management and position sizing. Proper money management
> ~ inherently manages and quantifies risk. It balances the trade-off
> ~ between risk and return.
> ~
> ~ Your own system, Terry, of risking a small percentage of your
> ~ account on each trade is, in fact, both risk management and
> ~ position sizing. It is a fixed fractional (Fixed f) anti-martingale
> ~ system, where position size increases as you profit, and it
> ~ decreases when you take losses. It will give you geometric
> ~ returns with arithmetic changes in risk. My question, though,
> ~ is how do you know that the percentage you choose is correct.
> ~
> ~ I'm not a great proponent of Optimal f or any other particular
> ~ money management system. What I do advocate (and I give
> ~ Ralph Vince full credit for my own epiphany) is quantifying risk
> ~ and return and making an informed decision.
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