Position Sizing - Betsizing: A Formula for Compounding Wealth
Position sizing refers to the “how much” in commodity trading, specifically how much you will risk or bet on each trade.
Edward O. Thorp, UCLA P.H.D, was one of the pioneers in position or betsizing. In his book Beat the Dealer, he created and used a betsizing strategy to beat the casinos at blackjack. He later took his methods to Wall Street and is said to have compounded his money at over 20% per year for over 28 years.
Position sizing can be categorized into two basic philosophies- martingale and anti-martingale. Martingale betsizing means you increase your bet as you are losing. It is more popular in gambling, which is a dependant trials process. Also, in gambling your odds can be calculated with a higher degree of accuracy than in trading.
Commodity trading is an independent trials process, which means that past results have no effect on current or future results. Successful futures traders overwhelmingly use an anti-martingale betsizing approach. This means they decrease their bet size as they are losing.
An example of this approach would be fixed fractional trading: a commodity trader will bet a percentage of his account on each trade. Successful futures traders who use this strategy will rarely bet more than 1% of their equity on each trade and usually a lot less.
When using a 1% trading size, a commodity trader will divide the risk on a new trade by 1% of their account equity. For instance, a trader with a $500,000 account whose system generated a buy order in corn with a risk of $2000 would place an order to trade 2 contracts ($5000 / $2000 = 2.5 rounded to 2).
As you can see, successful fixed fractional trading requires a large account size. For a trader that doesn’t have a large account size, it makes much more sense to use a unit-size betting strategy, rather than risking too much per trade to force a fixed fractional type strategy.
A unit-size strategy would trade 1 contract per x amount of dollars in your account. The strategy also needs to use a dollar risk cut-off amount to protect the futures trader from taking on too much risk per trade. As an example, you may take all trades up to a risk of $2000 and trade 1 lot for every $65,000 in your account.
Another way to use this strategy is to increase the required equity needed to add another contract. For example, trade 1 lot at $65,000, 2 lots when your account hits $150,000 and three lots at $240,000. This is a smarter way to increase your position size because you are decreasing your exposure as your account grows.
Whichever position sizing strategy you choose, remember that if your strategy doesn’t have a positive edge, then no betsizing strategy in existence will be able to make you money.
Commodity Trading Solutions' strategies have a positive edge and take advantage of advanced position sizing techniques.
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