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Basics #4:Achieving Your Goals Through Position Sizing

Welcome

G’day, Howdy, Guten Tag, Ni Hao, Вітаю, Hallo, Konnichiwa, Chào and welcome to session #4 of the Forex System Development Workshop.

Live and Interactive

Don’t be a Shy Sally or a Bashful Barry, ask questions,

take your time.

Review of Session #3

In session #3, we discussed trading the right strategy for the current market type.

Review of Session #3: The Concept Not the Method

The exact method is not as important as the concept of trading the right strategy for the

market type.

Review of Session #3: Entries and Exits Are a Different System

You identify the market type then use a different system to enter and exit.

Questions About Session #3

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Achieving Your Goals Through Position Sizing

What is Position Sizing?

“Your position sizing strategy helps you to determine how much equity to risk on every trade. Its purpose is to

help you meet your objectives” – Van Tharp

The Basics of Positon Sizing

Top Traders Think in Terms of Risk vs Reward (R-multiples)

An R-multiple is a way of expressing your trade in terms of risk.

Learn more: FCST Lesson #5

R-multiple Example

If you place a trade with a stop-loss 100 pips away from the market, and you are buying a standard lot, then your loss would be (roughly) $1000 if the trade

went against you.

This initial loss of $1000 is your 1R risk. The R, of course, stands for risk.

R-multiples Can Be Expressed Differently All of these are valid ways:

– As a percentage, for example 1Rp (percent) = 1% – In pips, for example 1Ru (unit) = 100 pips – In dollars, for example 1Rt (total risk) = $100

Your R-multiple is Calculated in Terms of Your Objectives

The most important for us today is percent risk. To determine what is right for you go back to your

objectives from session #1.

Learn more: FCST Lesson #5

Meeting Your Return Objective

Take your objectives from session #1– Targeted Return – Number of Trading Opportunities – Targeted Win Rate – Targeted Risk Reward

Simple: Fixed Percent of Equity Formula

Input your objectives into the spreadsheet to determine your starting position size.

Example: Percent of Equity

Managing Your Drawdown ObjectiveTake your drawdown objectives from Session #1

– Maximum drawdown– Percent chance of your maximum drawdown

occurring

Simple: Positon Size Reduction Threshold

Input your data into the spreadsheet to determine when you should reduce your

position size and by how much.

Example: Managing Drawdowns

Discussion point: Understand the Distribution of R-multiples in your System

Does your system typically have lots of winners or losers in a row?

This can impact how you manage drawdowns.

Protecting Your Core Equity

Trade at a much smaller size until your account is in profit.

“The most important thing is to keep enough powder for a comeback” – Marty Schwatrz

Example: Core Equity

Notional Funding

You may only allocate a fraction of your full account size to your broker. You will need to

adjust your position size for this.

Example: Notional Funding

Discussion Point: The Better Your System the More You Can Risk

The better your system works in the current market type the more you can risk.

“One of the fundamentals that you as a trader must know is how to evaluate the effectiveness of your trading methodology.” – Van Tharp, Market Wizard

The Nitty-Gritty of Position Sizing

Portfolio Heat

What is the maximum amount of risk you will allow on your account at any one time?

– Number of positions at one time – % of account at risk at one time

“The moral is you have to know your net exposure comfort zone.” – Jack Schwager

Example: Portfolio Heat

If you have seven trades on, all risking 1%, then your portfolio heat would be 7% (7 x 1%).

The Right Amount of Portfolio Heat

As a general rule most systems should not have a portfolio heat of above 15%.

Discussion Point: Adding Additional Positions

When your positions have had the profit “locked in”, you can add new positions.

Group Control: Correlations

Often trades in several currency pairs will have a high degree of correlation. If you have too many

correlated positions it can be like holding one big position.

The “Basket” Approach

If you want to take multiple correlated positions you can allocate a risk percent to a group of

trades.

Example: The “Basket” Approach

You allocate 3% risk to long USD positions. If you want to take 3 trades you would risk 1% each. If you want to take two trades you would risk 1.5%

each.

Synthetic Positions

If you are holding a long and short position in the same currency then you will end up with a

synthetic position.

Example: Synthetic Positions

If you are holding a long AUDUSD trade and a short EURUSD trade you effectively have a short

EURAUD trade.

Discussion point: Limiting Your Focus

You could choose to focus on trading only a small number of pairs to avoid confusion around

synthetic positions and correlations.

Open vs. Closed Risk

You can calculate your risk based off your open account equity or off your closed account

equity.

Different Trade Types

You may want to allocate different risk amounts to short-term trades compared to long-term

trades.

Example: Different Trade Types

For example:– Short-term 0.1-0.5%– Medium-term 0.5-1.0%– Long-term 1.0-3.0%

The Power of Markets Money

What is Markets Money?

Markets Money is the concept of using profitsto trade larger to improve your returns.

Learn more: FCST Lesson #7 & 18

“When I am more attuned to the market and playing with market money, I will increase my position size.” – Scott Ramsey

Closed Trade vs. Open Trade

You can use markets money on:– Profits you have made on your account– Profits you have made during a trade

Examples of Markets Money in Action: Closed Trade

Once you are up by 5% a month you increase your position size from 0.5% to 1%.

Examples of Markets Money in Action: The Stanley DruckenmillerMethod

Grind out the first 30% for a year and then go for a 100% year.

“The way to build long-term returns is through preservation of capital and home runs. You can be far more aggressive when you’re making good profits. – Stanley Druckenmiller

Examples of Markets Money in Action: Open Trade

When you are up by 2R in a trade you tighten your stop and double your position size.

“It helps greatly to have a long-term objective that you have derived by really doing your homework. You combine the long-term objective with the protective stop that you move as the position goes your way.” – Gary Bielfeldt

Examples of Markets Money in Action: Open Trade

When Does Markets Money Become Core Capital At what point do you turn markets money into core capital?

– A time period, such as a year– A profit objective such as 50%– A combination of the two

Position Sizing For Day Trading

Day Trading Has It’s Own Unique Challenges When day trading you should have very strict rules about:

– Maximum number of positions you take in a day– Maximum number of positions you hold at any

one time– Maximum loss in a day before you stop trading

Ken Long’s “Bullet Method”

Ken Long, an instructor with Van Tharp developed the Bullet Method specifically for day

trading.

Ken Long’s “Bullet Method”

Divide your capital into several “bullets” which you can fire each day. That is the number of

trades you can place in a day.

Ken Long’s “Bullet Method”

If you have a winning trade you can add to or top-up your bullets.

Ken Long’s “Bullet Method”

If you want to scale-in to a position you can “fire” a second bullet on the same trade.

Ken Long’s “Bullet Method”

If you get down to your last bullet you can split it in half.

The 2&10 and 2&25 Position Sizing Models

Both of these models reduce your trade size if your account goes into a drawdown and

increases position size as you go into profit.

Learn more: The Position Sizing Portal

Example:The 2&10 and 2&25 Position Sizing Models

Discussion Point: Combining 2&25 With the Bullet Method

Use the 2&25 to work out your risk for the day and then divide it into bullets.

Position Sizing Across Multiple Systems

Each of Your Systems Should Work Together to Achieve Your Goals

While each system should have it’s own objectives and position sizing model, they

should work together to achieve your overall goals.

Objectives of the System

You may decide to allocate more to a conservative long-term growth strategy than to

an aggressive system for example.

Amount of Leverage Required

Some systems will require more leverage than others, which could be a factor in your

allocation.

Correlations Across Systems

Some systems may be correlated, or even hold the same currency pair at the same time.

System Quality

You may want to allocate more to higher quality systems.

The Maximum Drawdown of Each System

You may want to allocate more capital to a system with a lower drawdown threshold.

The Holding Period of Each System (Daily, Weekly, Monthly)

A day trading discretionary system may require less capital than a long-term trend following

system.

The Recent Performance of Each System

If a system is going through a rough patch, you may increase or decrease its capital allocation

depending on its recovery profile.

The Current Market Type

You may decide to increase or decrease your allocation to certain systems in unfavourable market types (this includes decreasing it to

zero).

Questions

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Discussion Points

Your Session #2 Plan

Your entry and exit rules from session #2 are simply there to achieve the win rate and

risk/reward ratio component of your objectives.

Use the Models for Your Purpose

Feel free to adapt the models to any purpose that fits your personality and trading style.

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