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Van Tharp's Definitive Guide To Position Sizing book. Read 3 reviews from the world's largest community for readers. How to Evaluate Your System and Use.
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Indus: 29,277 +174.31 +0.6% Utils: 935 +3.14 +0.3% S&P 500: 3,352 +24.38 +0.7% | +2.6% +6.3% +3.8% | 29,650 or 28,450 by 02/15/2020 1,025 or 910 by 02/15/2020 3,500 or 3,250 by 03/01/2020 |
Indus: 29,277 +174.31 +0.6% Utils: 935 +3.14 +0.3% S&P 500: 3,352 +24.38 +0.7% | +2.6% +6.3% +3.8% |
29,650 or 28,450 by 02/15/2020 1,025 or 910 by 02/15/2020 3,500 or 3,250 by 03/01/2020 |
Below are simple methods to size positions for trading stocks.
Position Sizing: Background
For most of my investing career, I used a fixed dollar amount for money management when buying stocks. At the beginning, it was $2,000. That bought me 100 shares of a $20 stock. I thought that's the method that everyone used. As I learned about the stock market, I knew that there were better ways to position sizing (money management) but I didn't know what they were.
In the August 2007 issue of Active Trader magazine (www.activetradermag.com), Volker Knapp (see Trading system lab: 'Percent volatility money management') tested a system that used volatility to determine the position size. I already use volatility to determine stop placement (see Stop Placement), so this was a welcome addition. The article was based on Van K. Tharp's book Trade Your Way to Financial Freedom.
Position Sizing: Percent Risk
The first method, percent risk position sizing, is well known and it's based on risk to determine the position size. For example, if you are looking to buy a stock with a price of $20 and a stop loss of $19, with a maximum loss of $2,000, you should buy 2,000 shares.
The formula for this approach is:
DollarRiskSize/(BuyPrice - StopPrice)
In this example, the DollarRiskSize is $2,000, the BuyPrice is $20 and the StopPrice is 19 giving a result of $2,000/($20 - $19) or 2,000 shares.
Position Sizing: Percent Volatility
The percent volatility position sizing method adjusts the risk according to the stock's volatility. Tests described in the article say it performs much better than the percent risk method.
Here's the formula.
PositionSize = (CE * %PE) / SVWhere CE is the current account equity (size of portfolio)
%PE is the percentage of portfolio equity to risk per trade.
SV is the stock's volatility (10-day EMA of the true range).
For example, if the current account equity (CE) is $100,000, the percent of portfolio equity we want to risk (%PE) is 2%, and the stock's volatility is $1.25, then the result is: ($100,000 * 2%) / $1.25 or 1,600 shares. Instead of calculating the 10-day exponential moving average of the true range, I just calculate the volatility usingPatternz, which provides it at the click of a button. The downfall of these two methods is that if your portfolio is $100,000, then the trade just described would chew up 1,600 shares x $20 buy price or $32,000. Thus, you can buy just over 3 stocks, giving you a concentrated portfolio. Thepercent-risk method would be even worse with $40,000 used for just one stock. (Of course this assumes that the stocks share the same buy price, volatility, and so on). |
One way to avoid the concentrated portfolio problem is to divide the $100,000 into $10,000 allotments (or whatever size you feel comfortable with that would lead to a diversified portfolio), one for each stock. Use the same formula to determine the share size. In the percent volatility example, the computation would be: ($10,000 x 2%) / 1.25 or 160 shares.
I don't know what this does to the profitability of the method because the article's author didn't discuss this. In any case, this page is about position sizing and not portfolio theory.
Position Sizing: Spreadsheet Template
I have an Excel spreadsheet template which does the math for both techniques. To use the spreadsheet, first download it and then fill in the yellow cells with the appropriate information. The position size appears in the blue cells. The following shows what the template looks like.
Position Sizing: Bear Market
When a bear market begins, I cut my position size to limit losses. Recently, I decided to derive a mechanism to achieve that. The following table shows the rules for this new methodto limit losses in a bear market.
Market Decline | Position Size | Description |
0% to 19% | $20,000 | Do nothing since a bull market is intact. |
20% to 29% | $10,000 | Bear market begins. Cut position size in half. |
30% to 39% | $5,000 | Bear market worsens. Cut position size in half. |
49% to 100% | $2,500 | Bear market worsens. Cut position size in half. |
By definition, a bear market begins when an index (I use the S&P 500) drops 20% below a peak.When that occurs, cut the amount allocated to each trade by half. If my position size is $20,000, I will cut it to $10,000.
If the market drops another ten-percentage points, then cut the position size in half again -- from $10,000 to $5,000 in my case. Continue cuttingthe position size by half until it reaches $2,500 (or whatever value you choose).
The advantage of this position-sizing algorithm is obvious. As the bear market begins and worsens, your have the potential to lose less and less of your trading capital.However, this method does keep you in the market, so you can shop for bargains among a variety of stocks. That promotes diversity, which is also a good thing.
If there is a drawback, it's that at a bear market bottom, you are investing few dollars in the market. When the bull market resumes, that's when you want to pile back in.Of course, it's often difficult to determine when a bear market ends and a bull market begins, so prematurely ramping up the position size can lead to larger losses.
Position Sizing: Portfolio
How do you size the positions in your portfolio, assuming you wish to make multiple buys per stock (or just once)?
To get the position size (shown in the above table as $20,000 then $10,000), take the value of the trading account and divide it by the number of positions you want to hold.The number of positions you choose is up to you. Many will say to hold no more than 10 to 12 with at least 7 to 8 positions to give adequate diversity. As I write this in December 2010,I own 22 positions with an eye to 30. Think of this as my own private mutual fund. I'm a skilled investor/trader with 30+ years of experience, so owning this many is not a problem...butthat's just me.
For example, say you have a portfolio currently valued at $300,000, and want to hold 30 positions, then each position would be $10,000. Within 20% of a bull market peak, you'd start with 10k per position.When the bear market begins, you'd cut that in half, to 5k and then 2.5k as the bear market worsens.
That gives you the amount to invest in each stock. Now, let's adjust the position for volatility. The more volatile the stock the fewer shares you should own.
Shares Per Trade
I saw one algorithm that compared the current stock's volatility with its historical range. The 'current' period used a 10-day high-low calculation but they didn't specify whatwas meant by 'historical.' In their example, they said 'a few years ago' (whatever that means).
That bothered me. A company could have had a drug failure, dropping the stock by 70% in one session (huge historical volatility) and then sold the division. You might not knowthat unless you read the press releases or discovered it some other way.
I have a better idea. Why not compare the stock's volatility to the market's? Here's the formula.
Shares = (PositionSize * (MarketVolatility / StockVolatility)) / StockPrice
![Pdf Van Tharp Position Sizing Spreadsheet Download Pdf Van Tharp Position Sizing Spreadsheet Download](/uploads/1/2/6/5/126594984/230190375.jpg)
PositionSize comes from the above table, so it's adjusted for the market conditions.
MarketVolatility is the daily change of the market over the last month, averaged, expressed as a percentage.
StockVolatility is the daily change of the stock over the last month, averaged, expressed as a percentage.
For the two volatility calculations, I calculate the high-low difference of the stock or market index (I use the S&P 500 index) each day for 22 trading days (about a month),average it, and divide it by the most recent close. This is nearly the same calculation that I use for a volatility stop, so check that link for an example. You can use the ATR, but it's not as effective.
This will give you the number of shares to invest per position. You can have multiple positions per stock.
In short, take the ratio of the two volatilities to further adjust the bucks you spend and divide that by the current share price to get the number of shares.
Volatility Stop
We adjusted the amount spent per trade for the market conditions, and then we adjusted the number of shares for the stock's volatility.The third leg of the algorithm is to use a volatility stop. That calculates a stop loss order based on a stock's volatility in a manner similar to the above volatilitycalculation.
Thus, you have three pieces: Adjusting the position size for the market conditions, adjusting it for the stock's volatility versus the market's, and using a volatility stopto limit losses.
Position Sizing: Example
Let's assume we want to buy Gap (GPS) stock. It closed Friday, December 17, at 21.19. Our portfolio has a current value of $100,000 and we want to hold 10 stocks in the portfolio.
The S&P index is down less than 20% from it's high a few days ago (it's down less than 1% from the high). Thus, we'd spend the full $10,000 for this trade(that's $100,000 / 10 stocks = $10,000). To find the number of shares, the market volatility is 0.009 (0.9%) and the stock's volatility is 0.0213 (2.1%) -- I have a program that calculatesthe two volatilities automatically.Plugging this into the formula, we get,
Shares = ($10,000 * (0.009 / 0.0213)) / 21.19 or 200 shares (I round up to the nearest 100 shares). They would be worth 200 * 21.19 or $4,238.
The volatility stop would be placed at 20.15, or 5% below the current close.
That gives us plenty of dollars to spend on the stock sometime in the future, to increase the position. The volatility and portfolio value will have changed by then, so you'd runanother calculation to get the next investment amount.
-- Thomas Bulkowski
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Exercising adds minutes to your life. That means you'll spend 5 additional months in a nursing home at $5,000 per month.
I just got this in an email. I have the original. I beat the game the second time I used it and never used it again. It looks like they've made it more realistic and challenging. I'm not endorsing this, I'm just letting you know it's available. VT may not be the best trader in the world, but he does know a bit about Risk and Money Management, and all the issues that screw us up.I'm contacting you via email because you have purchased my trading simulation game 3.0 and I wanted you to know that the NEW Version 4.0 of The Position Sizing™ Game is ready for release!Since you already own the previous edition of the game, I have a very special upgrade price for you.Only $75Get version 4.0, at a big discount, and pay only $75! ( using coupon code.)You get a discount and still benefit from all the improvements in this latest version.
Most companies would charge you full price for an upgrade, for such a modified product.What's New?. Realistic Mode: People used to tell us that they had made trillions of dollars in the previous version of the game. While some of you may still want to do that, we’ve taken the game to a new level by adding a realistic mode.
Realistic mode allows for slippage, commissions, taxes, and trader mistakes to eat into your equity just as in live trading. The beta testers have been blown away by the cumulative effects on their earnings of all those “little” expenses. So here’s our challenge: buy the new v4.0 and see if you can make billions of dollars now in realistic mode, let alone get past Level 2 at 90% trader efficiency. It’s very, very tough! And it’s a lot more like real-life trading. New Screen Designs: The game’s greatly improved user interface makes the screens simpler, more informational, and more like what you are used to seeing when you trade.
Works on New PCs: You can now play the game on any PC running Windows Vista or Windows 7 (or on a Mac operating in Windows mode). Track Your Drawdowns: Get an idea of what drawdowns feel like and how big they might get using your own trading system’s results in simulation mode. Can you imagine living through a drawdown in your live account when you have already lived through a worse one in the game? That experience and knowledge can be invaluable. Simulate Your Own System: You can also simulate your own trading system by adding in the R-multiple distribution of your system. And while that's not new, with the new drawdown information you can now use position sizing(TM) to make sure you never reach ruin as we recommend in the Definitive Guide to Position Sizing.
Hands Free Updates: The game now automatically checks for updates to the game software, so you will always be playing the most updated code for the version available. Easy to Read Instructions and Help Section: The Instructions and Help Section have been completely rewritten. The updated section guides will help new players learn the game faster and guide experienced players with some position sizing ideas.The feedback on all of the improvements from our beta testers has been glowing. We took a lot of time to make the game an excellent teaching tool as well as a fun activity. Based on the initial feedback, it looks like we are meeting those objectives.To upgrade, Use this coupon code ' to get the special price of $75.What's The Position Sizing Game About?People always look for the 'real' secrets of master traders, but their mental biases cause them to look in all the wrong places and at all the wrong things. To many traders it seems that success will come with the ultimate stock picking methods or magical trading systems with 80%+ winning trades. Picking the right stocks has nothing to do with trading success and neither do amazing trading systems with high percentage wins.How then do you become a master trader?
The Market Wizards agree that there are three keys to trading success:(1) Follow the golden rule of trading—cut your losses short and let your profits run.(2) Master the part of your trading that tells you how much.(3) Develop the discipline to follow both of those elements.This game will help you focus on one of the three most important aspects of trading—position sizing™ strategies. Additionally, it will help you learn how to let your profits run—and protect them, as well. Finally, playing the game numerous times using your own system’s results in simulation mode allows you to practice proper position sizing and can help you develop the discipline to follow the other two keys for trading success. I designed The Position Sizing Game to help you learn these keys to trading success without risking your capital.As with real trades, there’s only one position sizing question to answer in the game: “How much do I risk on each position?” You establish the risk amount in two ways: through your initial stop price (your risk per share) and your decision about how many shares to buy (which determines your total risk). Do this well and you are on your way to profits. Do this poorly and you blow up your account.To complete the game, you have to prove your proficiency in four key principles: (1) the importance of R-multiples; (2) the difference between expectancy and probability; (3) letting profits run without letting them escape; and (4) using position sizing strategies to make sure you have a low-risk trade.
The Position Sizing Game is designed to drive these principles home by giving you the experience of making (or losing) money in a game environment where losing is safer.Through the game, you’ll begin to understand these principles experientially without having real money at stake. My book, explains all of these ideas conceptually if you are interested.To upgrade from version 3.0 to 4.0 and use coupon code ' to get your discount. This code is intended for your use only. Please do not distribute it to others.
This offer expires March 31st.Thank you. I hope you love playing Version 4.0 of The Position Sizing Game as much as I do.Sincerely,Van K. TharpTrading CoachThe Van Tharp Institute. Don't get me wrong, I think that Van's a clued-up guy, and an articulate author, even if he doesn't trade himself.However, a couple of points:1. IMO Van makes position sizing overly complex.
In reality, all that's required is to keep sizes small enough to protect capital against the possibility of series of losses. I don't mean to sound conceited, but I don't need to purchase a game to prove that to myself.2. Keep in mind that Van's trading strategies are not necessarily forex-specific. For example, if we take 'cut losses quickly; let profits run', that is profitable only to the extent that markets trend. I recall reading a of Daytrading's where he said 'FX has short trends and no directional bias except carry. His view of this asset class being the most 'trendy' is delusional at best.'
Hence we would need to find setups with a higher-than-normal propensity to trend, in order to maximize the potential of this strategy.I posted in more detail on all of this. Don't get me wrong, I think that Van's a clued-up guy, and an articulate author, even if he doesn't trade himself.However, a couple of points:1. IMO Van makes position sizing overly complex. In reality, all that's required is to keep sizes small enough to protect capital against the possibility of series of losses. I don't mean to sound conceited, but I don't need to purchase a game to prove that to myself.2. Keep in mind that Van's trading strategies are not necessarily forex-specific. For example, if we take 'cut losses quickly.
IgnoredI agree for the most part. I tried the demo of the above and concluded that I already know what he's trying to teach (I did do a seminar with him and we spent a day on MM). Also, the program above utilizes some huge assumptions, some of which I've yet to encounter in trading FX. Specifically, that there are going to be quite a few losses which get out of control so that you end up with ones that are 5 and even 10x your planned loss. I've seem some get up to 2x due to executions errors but that's it.I suppose when people are new that it will happen due to not closing losing positions and not using a SL, but those folks wouldn't utilize the principles he's trying to teach anyway.I think all anyone needs is to read his book TYWTFF and study the MM section.
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