![]() They work best when the distribution of bet returns is stationary (as a roulette wheel) and the amount won equals the amount lost - neither of which is true for trading results.īe wary when applying simplistic position sizing. It is important to analyze the entire distribution of returns - not just the mean, or even the mean and standard deviation. The critical limitation to maximum position size is the number and magnitude of losing trades, but the entire distribution must be taken into account.Įvaluation of risk is very subjective, but it can be quantified. "I am willing to accept a 10% risk that the maximum intra-trade drawdown (measured from highest equity to date) over the next two years will be no greater than 20%." Every trader should quantify his or her own personal risk tolerance. The analysis techniques I describe in "Modeling Trading System Performance" estimates the maximum position size for the combination of:Ģ. A specific statement of risk tolerance.Īs real (or paper) trades are made, those trade results should be used to keep the "best estimate" set of trades up to date in a Bayesian-like manner. This gives the trader the tools needed to monitor system health and adjust position size as system performance varies. Systematic analysis of risk, position sizing, and profit potential requires unambiguous identification of trades. This is fairly easy with formula-based systems, and more difficult with discretionary systems.
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