Position Sizing

[carltonp 10]

Hello Fellow Traders,

 

I'm not sure if I'm phrasing this question correctly, but here goes.

 

As you'll probably guess from the following question, I'm fairly new to trading.

 

Over the last 10 weeks, 02/22/2011 to 04/01/2011 I have placed 46 trades. I currently trade equities.

 

Sixty one percent of the trades closed at a profit. However, the Pay-off Ratio is terrible, 0.64.

 

At the moment, I'm risking $100 per trade with R/R of 1:5. So for every $100 I would like to achieve $150. I size my trades purely on how much I would like to risk and how much I would like to gain. Therefore, the number of shares I purchase would be determined on this factor alone.

 

I would say that most of my winning trades close for about $100 and my losing trades stop me out at $100. The reason why I mention that is because it would seem the poor pay-off Ratio is partly due to taking profits before they reach $150 but always letting my losses run until they stop me out at $100. However, I don't believe that is the major reason for the poor pay-off ratio.

 

I believe the major reason for the poor pay-off ratio is due to bad position sizing. The problem is I don't know the best way to size my positions, other than how much I'm will to lose and how much I want to gain.

 

Another option is to stop trading equities and start trading another financial instrument.

 

If any of you guys/girls can give me some advice on position sizing and what instruments you think are better traded than equities (bearing in mind I'm a relatively new to trading) I would be very grateful.

 

Cheers

 

Carlton

[shakespeare515 10]

Hello Fellow Traders,

 

I'm not sure if I'm phrasing this question correctly, but here goes.

 

As you'll probably guess from the following question, I'm fairly new to trading.

 

Over the last 10 weeks, 02/22/2011 to 04/01/2011 I have placed 46 trades. I currently trade equities.

 

Sixty one percent of the trades closed at a profit. However, the Pay-off Ratio is terrible, 0.64.

 

At the moment, I'm risking $100 per trade with R/R of 1:5. So for every $100 I would like to achieve $150. I size my trades purely on how much I would like to risk and how much I would like to gain. Therefore, the number of shares I purchase would be determined on this factor alone.

 

I would say that most of my winning trades close for about $100 and my losing trades stop me out at $100. The reason why I mention that is because it would seem the poor pay-off Ratio is partly due to taking profits before they reach $150 but always letting my losses run until they stop me out at $100. However, I don't believe that is the major reason for the poor pay-off ratio.

 

I believe the major reason for the poor pay-off ratio is due to bad position sizing. The problem is I don't know the best way to size my positions, other than how much I'm will to lose and how much I want to gain.

 

Another option is to stop trading equities and start trading another financial instrument.

 

If any of you guys/girls can give me some advice on position sizing and what instruments you think are better traded than equities (bearing in mind I'm a relatively new to trading) I would be very grateful.

 

Cheers

 

Carlton

 

Hi Carlton,

 

I think a good amount to risk is somewhere between 1-4%, depending on the trader.

If you are new, you should STILL BE ON DEMO until you develop some consistency, but when you start to, then maybe just start at 1% (it's not sexy, but you must keep your risk low in the beginning.

 

To calculate your lot size, do the following..

 

Example account size $1000:

 

• 
  Identify your trade including stop loss and target.

 

• 
  If your stop loss is 100 pips, and you only want to risk 1%, then you must make 100 pips = 1%.

 

• 
  1% of $1000 is $10, so you cannot risk more than $10 on this trade, so you must divide the $10 into 100 pips..

 

$10/100 pips = 0.1 $/pip

 

what size lot will give you $0.1 per pip?

 

Answer: 1 micro lot.

 

So on a trade with a 100 pip stop, witha $1000 account and 1% risk..

you should trade 1 micro lot,

 

If you were risking 2% you could trade 2 micros,etc.

 

Hope this helps,

Sam

[shakespeare515 10]

All that was assuming you are talking about forex, of course..

[carltonp 10]

Hi Sam,

 

That helps immensely. I will take your advice and use your example with my future trades.

 

Cheers mate...

[TheNegotiator 13]

Hi carltonp,

 

First of all, welcome to TL! If I understand what you are saying correctly, you have made about $1000 pre-commissions. If that' the case, and your commissions are not putting you under water, it's not bad at all. Most noobs are expected to lose money to begin with. One thing I'd definitely note though is the that although you are on the face of it trading profitably, a 1:1 risk:reward ratio is probably not going to be especially great in the long run when you are only taking 1 trade in 5 as overall profit(3 win -2 lose). So I think it's worth taking a look at your strategy again and analysing whether or not your winning trades usually continue in the same direction and what the normal MAE (max adverse excursion)of those winners is so you are efficiently placing your stop at the point where you are wrong. In the case of where you take profit, it may or may not be appropriate to scale some of your position off in order to let it run further but with lower risk and trail your stop. However, this of course depends on the market you trade, the strategy you employ and your commission structure. The other thing is you should really keep updating your analyses as 46 imo is probably a bit of a small sample size.

[MightyMouse 12]

Carlton,

 

Its all going to depend on what you are trying to accomplish, what your risk tolerance is, and the size of your account.

 

A 1 to 1.5 R/R is mathematically a valid R/R depending on your percentage winners. To get the 1.5 reward, you are going to have to leave the position on and not second guess the success or failure of the trade before it succeeds or fails. The fact that you have pulled the trade at 1 to 1 is actually reinforcing a bad habit. You have to let it stay and figure out the real success rate of the method you are using. If you are trying to do a stop or target method, then leave the computer and let either the stop or the target to get hit.

 

If you continue pulling the trade before the trade is over, your size winner will begin going down even though your percentage winners remains high. You will be frustrated because you are mostly correct, but you are losing money. I have lived this. Lots and lots of traders have. The sooner you fix this the better.

 

I literally walked away and came back 15 minutes later. While i was away, I simply accepted the fate that I would find when I get back. When I got back most of the time it was still at my entry even though I thought i was stopped out. I would leave again until i was filled one way or the other. It was great. It was like a grieving process for the death of fear. Soon I was able to just sit there and not think about it and follow my trade.

 

If you are going to trade live, risk as little as you possibly can until you can turn a profit. You won't miss much if you risk less than 100. If you miss out on trades that make 150 gross per trade, you aren't missing much anyway, but if you are trading with a small account, 100 could do damage pretty quickly.

 

Good luck

 

MM

[carltonp 10]

Negotiator/MightyMouse,

 

Thanks ever-so-much for responding.

 

I'm reading and re-reading your comments before I respond.

 

In the meantime, are you guys essentially saying the issue isn't necessarily position sizing but having the courage to let my trades continue to my profit target?

 

To be totally straight with you, what I've been doing is letting the price go beyond 1:1 target of $100. Once it goes past the price by say 5 ticks I'll raise my stop to $100. The thinking behind that is if the price goes down to my newly raised stop its going to to down much further - and almost every time it does and I just come out with $100 instead of my target of $150.

 

I know the last statement is poor grammar but does that make sense?

 

Negotiator, thanks for welcoming me to TL.

 

Cheers

[carltonp 10]

Sam,

 

I did mention that I trade equities, not forex. Therefore, your sample may not relate to me?

[carltonp 10]

MM,

 

I just read your comments again, for the third time. I'm going to take your suggestions, along with The Negotiators comments on board. However, I would like hear your thoughts on position sizing?

[MightyMouse 12]

Negotiator/MightyMouse,

 

Thanks ever-so-much for responding.

 

I'm reading and re-reading your comments before I respond.

 

In the meantime, are you guys essentially saying the issue isn't necessarily position sizing but having the courage to let my trades continue to my profit target?

 

To be totally straight with you, what I've been doing is letting the price go beyond 1:1 target of $100. Once it goes past the price by say 5 ticks I'll raise my stop to $100. The thinking behind that is if the price goes down to my newly raised stop its going to to down much further - and almost every time it does and I just come out with $100 instead of my target of $150.

 

I know the last statement is poor grammar but does that make sense?

 

Negotiator, thanks for welcoming me to TL.

 

Cheers

 

So when you move your stop up to 100, you will make either 100 or 150? If that's the case then you are saving yourself on some and stealing from yourself on others. Sometimes its going to be better that you do that. sometimes its not. All the data in the world will not tell you which way will work best in the future. I would suggest that if you are going to move your stop when it goes 5 ticks past 100 that you move your target up by 100 or so that your new target is 250 instead of 150. My thinking is that if the market is so strong that it does not come back and take you out at your stop, that it has a good chance of going past your target. There really is no right or wrong answers.

[carltonp 10]

MM,

 

Thanks again for responding. Apart from moving my profit target up when the price goes say 5 ticks past $100, would you say my system is profitable?

[MightyMouse 12]

MM,

 

Thanks again for responding. Apart from moving my profit target up when the price goes say 5 ticks past $100, would you say my system is profitable?

 

If you are up, it is profitable. No question about it. You captured something with your system that takes money from the market.

[sappjason 10]

I'm not a discretionary trader, but rather an automated day trader that trades exclusively US equities. So, as far as your position sizing questions are concerned, I'm just going to state the obvious. Here it goes:

 

If you determine that you want to go long stock XYZ at $50.25, you must also determine exactly where you are willing to get out for a loss. Lets say that you determine your stop loss location to be $49.75. This gives you a $.50 cent stop size. If your max risk is $100, then you should purchase 200 shares at $50.25 and place your stop at $49.75..... Lastly, your exit location (for your profit) would be $51.00 (for a profit of $150).

 

Now, with all of that said, there are other costs involved here that you already know about. Namely commissions and slippage. In most cases, commissions are easy to determine, but slippage is the hard part (especially on your stop). As your position sizes grow, slippage will eat away at your bottom line much more than commissions (I'm at this point with what I'm doing now). In fact, with any momentum based system that needs to rely on market orders for entry (where position entry is more important than price), you will eventually hit a brick wall where your percentage returns will diminish to the point where trading that way no longer makes sense.

 

Back to the matter at hand..... If you purchase your 200 shares at $50.25 and it hits your stop location of $49.75, your real risk is actually more than $100. It will be $100 + commissions + slippage (on your exit and entry---if you used a market order to get into your position).

 

My ATS software estimates how much it thinks it will slip the position it's about to enter and then size the position down to account for slippage on entry and exit (I use market orders for entry and mostly stops for exit, so this incurs a lot of slippage). My risk size is currently about $600 per trade and because I'm a day trader, my estimated slippage is typically kind-a high. Therefore, many times, my system sizes the position size down quite a bit, so that my commissions and estimated slippage never account for more than 10% of the total risk size. In other words, if my desired max risk size is $600, I don't want slippage and commissions to add up to more than $60.

 

Lastly, moving your stop after your position is in the green by a certain amount is not a bad thing, but it would really be helpful to you if you understand how this stop movement affects your EV over the long haul. In other words, have you back-tested what you are doing to determine if you think your system is actually profitable (over the long haul)?

 

Jason

[carltonp 10]

Hi Jason,

 

Thanks for you comments mate.

 

I've read it, but will need to re-read it over again for it to sink into my brain. I totally understand where you say "If you determine that you want to go long stock XYZ at $50.25, you must also determine exactly where you are willing to get out for a loss. Lets say that you determine your stop loss location to be $49.75. This gives you a $.50 cent stop size. If your max risk is $100, then you should purchase 200 shares at $50.25 and place your stop at $49.75..... Lastly, your exit location (for your profit) would be $51.00 (for a profit of $150)."

 

 

However, I think I also need to follow MightyMouse's suggestions and learn to walk away and let my profits run until the target is hit. At the moment, instead of letting my trades reach its target of $150 (which is 1:5) I'm taking profits at 100 (which is 1:1).

 

I'm sure once I've read your comments again, I'll have a few questions.

 

Thanks again mate...

 

Carlton

[sappjason 10]

Yep, I agree with MightyMouse as well. I trade a bit differently in that my computer either takes me out or does not. My problem lies in the fact that I friggin' watch my system like a hawk and cause myself unneeded stress, because there's nothing that I would do to any of my positions either way.....

 

Good luck.....

 

Jason

 

Hi Jason,

 

Thanks for you comments mate.

 

I've read it, but will need to re-read it over again for it to sink into my brain. I totally understand where you say "If you determine that you want to go long stock XYZ at $50.25, you must also determine exactly where you are willing to get out for a loss. Lets say that you determine your stop loss location to be $49.75. This gives you a $.50 cent stop size. If your max risk is $100, then you should purchase 200 shares at $50.25 and place your stop at $49.75..... Lastly, your exit location (for your profit) would be $51.00 (for a profit of $150)."

 

 

However, I think I also need to follow MightyMouse's suggestions and learn to walk away and let my profits run until the target is hit. At the moment, instead of letting my trades reach its target of $150 (which is 1:5) I'm taking profits at 100 (which is 1:1).

 

I'm sure once I've read your comments again, I'll have a few questions.

 

Thanks again mate...

 

Carlton

[carltonp 10]

Thanks Jason. And Good Luck to you too mate

[TheNegotiator 13]

I think there is merit in both methods of exiting. Scaling out and/or trailers can be helpful in uncertain and volatile markets. Trending markets are possibly better suited to using fixed profit targets. What I have always noted in my own personal trading is that if I had taken something off the table in every trade I have ever placed which had shown a profitable phase, I would have considerably more money now. So I have tried to factor it in to my plan to do this even though often my full target does get hit. I know that for me it makes my plan more robust. Don't think as I am saying this that you should do this too. I personally trade in such a way that most of my trades do show some profitability at some point(MFE). But it depends what your strategy is, what your selected market is, what the market you trade is doing, your risk profile etc.

[steve46 12]

A couple of comments.

 

Most retail traders look at the chart and think "does this setup look good"? and then if they have some education and judgement they may have a rule for size (most of them simply trade one or two contracts so that is a moot point)...and then they may have a foggy idea of what the potential profit is going to be...and again (as you well know) most retail traders THINK they will hold a position but end up trading for ticks...and watching the rest of the move from the sidelines...

 

Much of this problem is lack of perspective...in that they don't think in business terms...for example time is money...there is an equivalency that you have to respect...within a certain time frame, you need to generate some profit, or you need to close out and move on to the next opportunity. If you have done some homework you know what your average hold time is for a winning trade, and conversely you know (or you should know) what your hold time is for a loser...Clearly you should strive to hold on as long as possible for winning trades and close down the losers as soon as you have identified them as unproductive.

 

If and when you obtain sufficient capital to move some size, you can take that opportunity to scale into your winners...Most professionals do this (in a specific manner) so as to insure that they have their biggest position size on when they are winning. Although I don't have time to provide the blow by blow details, I can say a couple of things that might help in this respect.

 

First, for each trade I take, I KNOW that there are going to be three (3) places where I can add size..I also know that adding size changes my risk profile, so I prefer to increase size as soon as I know that I have correctly identified market bias (as soon as I know I am on the right side). Often I am able to add to a winning trade within the first point or two...and it is often the case that I will double my position at that point....The opposite is also true...and that means logically that I will remove size if I don't see the market acting as I anticipate....and the result is that I will still take my full stop loss when I am wrong, but the stopout is taken on a position that is significantly reduced and thus the impact on my account is relatively small....clearly a lot of this is dependent on skill and judgement...

 

I hope I have given you something to think about

 

Good luck

[SIUYA 11]

great comments Steve.

This becomes particularly relevant when trading equities where the margins are not quite as favourable as futures or FX.

Often a question asked is - do I need to be here, and are there better opportunities to which to deploy my money. You want to be putting it to work with the winners, and to where the best opportunities present themselves.

Not as relevant to a single futures market participant trading smaller contract sizes, but still a good habit to get into.

[BlowFish 10]

You might want to consider RoR (Risk of Ruin) at the same time. This is a great little free site that explains it simply TradersCALM - Calculating risk of ruin

 

Knowing, and being comfortable with the likely hood of wiping maybe worth considering alongside maximising your gains. Chances are the latter will have some sort of impact on the former.

[TheNegotiator 13]

Nice exercise BlowFish. I wonder how many traders really grasp these kinds of concepts. Not many I would guess.

[CYP 10]

 

However, I think I also need to follow MightyMouse's suggestions and learn to walk away and let my profits run until the target is hit. At the moment, instead of letting my trades reach its target of $150 (which is 1:5) I'm taking profits at 100 (which is 1:1).

 

Hi Carlton, please excuse my ignorance, but I'm trying to understand your risk:reward calculation. In order for you to win $150 by risking $100, I show a risk:reward ratio of 1:1.5 and not 1:5.

 

If it was was 1:5, wouldn't that mean you are risking $100 in order to win $500?

 

This is minor, but I want to make sure I have it correct regarding risk:reward statements.

 

Thanks,

 

CYP

[Trader1 10]

and what about leverage? shouldn't you also calculate that? and pip value?

since all pairs have different pip value,