On to position sizing…
I can tell you that the more research I’ve done and the more I implement risk based position sizing: the more convinced I am than ever that it’s just about the keys to the kingdom.
I’m posting the link again here as I believe this is very important. Best part (which I will demonstrate) is that it doesn’t apply only to this trading system i.e. it could be used with anything. And I tell you: as somebody who just cannot stomach being taken out by a stop (it really does do my head in and actually affects my trading and this I noticed in prior years) it’s the best thing since sliced cheese.
First of all my position sizing is now based on the following (a slight modification to the formula presented and slightly more conservative):
Shares To Buy = ( 2% of Total Equity) / 3 * ( 10-Day Average True Range )
Lot Size = ( 5% of Total Equity ) / 5* ( 10-Day Average True Range )
Now why do I say this could be the keys to the kingdom for just about any trading system.
Check this out (and using a FOREX pair to demonstrate):
Assuming capital of $55K (R55K) (long story).
5% Risk: 2 750
ATR(10) x 5: 0.0225
Lot Size: 12.20
Now check this out:
If I just went long AUDUSD right now @ 0.69065 with a lot size of 12.20 my soft stop would be at 0.66811. Just take a look and see how far away that is on a chart. But: I’m still getting 1.22 per pip movement. My point is: let’s say you have an entry method (could be SR or one of the other trading systems like the RSI Rollercoaster for example) you could loosely enter a trade in the direction indicated and the chances of that trade turning to a profit at some point in time are EXTREMELY high. So with these wide stops you would simply wait for the trade to move into a profit and then start trailing a profitable stop.
I guess what I’m saying is that it is the stops that kills this business. Just using AUDUSD as an example: it’s not rocket science to figure out where most stops will be placed. And they will be gunned by the market. But with ultra wide stops such as these: that’s not going to happen. But your pip value is still quite substantial.
Now I’m not about to start trading FOREX pairs I assure you. But to most: I know the instruments that I trade are of little interest hence my using a FOREX pair for the purposes on demonstration.
Now let’s also say that you base your position size as I’ve noted. And let’s assume that you do indeed follow a trading system that clearly defines where your stops will be placed albeit that they will end up at very obvious places. Even if you then get stopped out and have to re-enter the initial trade: you are no longer wiping out 1% or 2% or 5% of your account on every single trade. That sh*t adds up very quickly let me tell you.
Of course: this will all have you trading much smaller lot sizes that you probably would be able to. Or would it??? And here we come to the wonderful dance that exists between this method of position sizing and capital and leverage. With low leverage: you would not be able to take a trade that would have you place tight stops and that would realize a 1%, 2% or 5% loss on that trade. Because of the tight stop: you position size could be absolutely HUGE BUT FOR ONE THING: you would not have enough capital to take the trade.
This post I don’t think is going to be too easy to understand. But read it and mull it over and you’ll see what I’m getting at.
Anyway. Here’s the link again. This is good stuff.