Monday, July 12, 2010

Position sizing...

Over the weekend I had what some would call a Eureka moment. I have been trading the Price Headley system for a few months now and I have had mixed to bad success. Not on my entries, a little bit of trouble on the exits, but also position sizing and profit taking. I have had big problems with the latter 2 critical areas of trading.

I had not given much thought to position sizing in the past. I just figured I wouldn't put more than 10% of my folio into a trade...however, recently I had heard a few May Tom Sosnoff was constantly repeating that in periods of high volatility you can reduce your position size and make just as much money as in low volatile times...Then I read the turtle rules. They actually quantified position size based on "N" which was racking my brain for a long time but really its just the Average True Range or ATR.

Then in my googling I found some videos from the fellas at in which they delved deeper as to risk determination.

Anyway this weekend I pieced all of these together to make my own position sizing formula. I even toyed with one for options.

1st determine what you are willing to loose on a trade. For me this is 1.5% of my total portfolio (this is a little conservative but still fairly aggressive...then determine the ATR of what you want to trade....divide your risk $by the ATR and have the # of shares you can trade of whatever it is you are going to trade.

A stop must be in place 1 ATR below your entry point...which is determined by your execution of the trade.

This means that all trades will only loose the amount you have determined you are willing to loose. Plus ATR will determine your position size...if you have a winner and your position size is bigger so will your profits. Of course ATR is independent of winning or loosing but it is a measure of volatility, so if something is moving quickly you will put less capital behind it...but still the same money.

Anyway this is the best way I have determined to quantify position size based on volatility. I will be using this moving forward.

I have also developed it for options, in this case you have to take ATR and multiply it by Delta and use that as your denominator...if you use a high delta, with low theta, this should keep the rest of the greeks from messing with the formula too that being said. It can work on options as well...the problem is with options you generally have more slippage so your risk is always going to be a bit more...even with the most liquid options.

So I am going to trade in equities using this strategy for now...and I will monitor the success of the options position sizing...for one this will allow me to enter breakouts instead of just retests because my risk will still be defined...

However, on retests this is of course even more powerful because that 1 ATR will allow for a bend don't break scenario (up to a point) and that point is the breaking point of the folio.

So no longer will I be waiting for the close...sorry Headley....I will be waiting for the ATR stop to be triggered...even if it happens intraday.

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