Fixed Ratio or Fixed Fractional?? – Pros and Cons of Each ...

[Andrew Peskin <andrew@xxxxxxxxx>]

(I apologize as this is somewhat long ...)

I would like to start a discussion on the merits and weaknesses of the
Fixed Ratio position sizing method popularized by Ryan Jones.
Specifically how does it stack up against the other predominant position
sizing method known as Fixed Fractional.

The majority of the research I have conducted was based upon the fixed
fractional method, or sizing your position based upon the risk the
position represents and the percent of your total equity you wish to
risk.

For Example:

You have a $100,000 account balance and wish to risk 10% of your account
on each trade, or $10,000.

You have an S&P Trading System which buys on a breakout of the highest
high of the last 5 bars and sells on a breakout of the lowest low of the
last 5 bars.  You would reverse your position with each occurrence. (I
am not advocating this system, nor have I tested this, I am only using
it as an example).

Your first trade has a risk of $2,000 so you would trade 5 contracts
(10,000 / 2,000 = 5).

Your first trade is a $750 winner so your account balance is now
$103,750.

Your second trade has a risk of $4,250 (the market has a greater 5 day
range) and you would trade 2 contracts (103,750 / 4,250 = 2.44 ==> 2).

You would continue this as long as you traded.

The above makes sense logically to me.  With the Fixed Ratio Method, I
see some Problems:

1.  How many contracts do you trade on your first trade?  The method
explains how to change your size once you have begun trading, but I am
unclear on how to size your very first trade.

2.  All trades are sized the same.  Why would you want to risk varying
amounts of capital?  In the above example if you were trading a fixed 4
contracts per trade, you would assume risk of $8,000 on the first trade
and a risk of $17,000 on the second.  I do not understand why different
trades should represent differing amounts of risk for your account if
the outcome of each trade is unknown and as the same probability of
success or failure.

I hope that this is a good start for an educational discussion amongst
ourselves regarding what many consider the most crucial aspect of
successful trading.  I am looking forward to following the ensuing
dialogue.

Best regards,

Andrew Peskin