48. Why Fixed Position Sizing Is Not the Best Way to Trade

http://www.informedtrades.com/
A lesson on how using a standard amount per trade when trading the stock, futures, or forex markets is not the best way to go.

In yesterday's lesson we introduced another important yet often overlooked aspect of trading and money management which is position sizing. In today's lesson we are going to begin to look at some of the strategies that many successful traders use to determine their position sizes.

As we discussed briefly in the last lesson many traders make the mistake of choosing an arbitrary number such as 1 contract or 100 shares of stock to trade when they first enter the market. In addition to the fact that this does not consider the amount of capital a trader has at his disposal, it also does not take into account the fact that the Dollar value as well as the volatility characteristics of one contract or 100 shares of stock is going to very greatly. Like a poker player who bets the same amount on every hand, this also does not allow a trader the flexibility to trade bigger on trades with a higher probability of success and smaller on trades with a lower probability of success.

As you can see from the picture below, a trader trading 100 shares of a $20 stock which fluctuates 5% a day and a second position of 100 shares of a $30 stock which fluctuates 1% a day does not present the risk/reward picture that many traders would expect it would. In this example the smaller position actually has a greater potential risk and reward because of the greater volatility of the first stock in the example.

Chart Example

The next level of sophistication up from the above, is trading a standard trade size such as 1 contract or 100 shares of stock for every fixed amount of money. As Dr. Van K. Tharp points out however in his book Trade Your Way to Financial Freedom, there are several distinct disadvantages to using this method which are:

1. Not all Investments are Alike (100 shares of a $10 stock which moves 5% a day is not going to be the same as trading 100 Shares of a $10 stock that moves 1% a day)
2. It does not allow you to increase your exposure rapidly with small amounts of money
3. You will always take a position even when the risk is too high.

As you can hopefully see from the above information, while the fixed position size per dollar amount is better than simply picking a number of thin air, there are many disadvantages to this method. In tomorrow's lesson we will begin to look at some different ways of overcoming these disadvantages starting with a discussion of the martingale and anti martingale position sizing strategies so we hope to see you in that lesson.

As always if you have any questions or comments please feel free to leave them in the comments section below so we can all learn to trade together, and good luck with your trading.

Category:

Howto & Style

Tags:

• howto
• trade
• position
• sizing
• daytrade
• investing
• money
• finance
• business
• forex
• futures
• stockmarket
• informedtrades

[trapatu]

Hey, thank you man, thank u for showing al these videos for free. I'm trading till 12 years and it's really nice to return in my "trading youth", when I didn't know anything about MM and had to "invent" it for myself.

All traders should be grateful for your videos. I greet you, Great Man, and wish you best of the best. Sorry if my english is not flawless :)

[InformedTrades]

Hi Trapatu, Thanks for the comment I appreciate it and don't worry your english is perfect. Best Regards, Dave

[willietrader]

Money management keys to the kingdom

[InformedTrades]

Thanks for the comment, I couldn't agree more. Best Regards, Dave

[dirtyal1234]

i have been guilty of this.

does trading in an even increment, i.e. 100 shares get you a better price than say 37 shares?

[AirelonTrading]

Making a short video for it now . . .

[InformedTrades]

great looking forward to it.

[AirelonTrading]

Running out the door at the moment, but I have it listed on my To Do: sticky here at the computer . . . :)