Position Sizing Methods for Trade Risk and Portfolio Protection
Summary
The article surveys ways to choose trade size, beginning with account risk, the amount of capital exposed to loss, and trade risk, the distance between entry and a stop. It contrasts fixed units, fixed dollar amounts, fixed percentages of account value, and fixed fractions that adjust exposure for risk. It also describes the Kelly criterion, which uses win probability and average win-to-loss size, and optimal f, which searches historical returns for a size that maximizes a chosen profit measure. The examples are illustrative rather than a general prescription.
For portfolio-level protection, it explains constant proportion portfolio insurance (CPPI), which allocates between risky and safe assets according to a cushion above a floor, and TIPP, which raises the floor as portfolio value reaches new highs. The article reports lower drawdown in its TIPP example, while noting that returns also fell; the supplied text gives limited detail on the underlying test. It cautions that sizing can manage exposure but cannot turn a strategy with negative expectancy into a profitable one.
Key ideas
- Position sizing sets the capital allocated to a trade, strategy, or portfolio and can make risk rules more consistent.
- Fixed units and fixed sums keep exposure nominally constant, while fixed percentages scale with account value.
- The Kelly criterion estimates exposure from win probability and average win-to-loss size but simplifies the distribution of outcomes.
- CPPI shifts allocation between risky and safe assets according to the portfolio cushion above a floor.
- TIPP raises its floor as portfolio value reaches new highs, which may reduce drawdown while also lowering returns.
- Position sizing can alter a strategy’s risk and return profile but cannot repair negative expectancy.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.