Magazine article Modern Trader

Sound Off!

Magazine article Modern Trader

Sound Off!

Article excerpt

Position mis-sizing? ["Volatility Matters: Better Position Sizing," May 2001], while conceptually on the right track, misses the mark in explaining position sizing.

[I]t is not correct to divide the price of the stock into the percent of capital risked to calculate the number of shares to buy. That decision needs to be a bottom-up decision that is a function of the maximum risk (1-R) as determined by your system.

[L]et's say you have developed a system that has a protective stop of 5% of the entry price. If that entry price is $50 per share then the protective stop will be at $47.50, and per-share risk is $2.50. This is the figure to divide into your 1% of capital per-trade risk. For a $100,000 account that is.. $1,000. Therefore, you would purchase 400 shares....

If you used a protective stop calculated using [average true range, or ATR] then, depending on recent volatility, that protective stop will vary.... If recent volatility is up, the stop will be larger and, hence, the number of shares will be smaller.

[The article's] methodology and example achieved these results, but [it] did not acknowledge that it is really the system and stops..that determine actual risk. The price of the stock is relevant only in [that] it allows you to determine 1-R risk....

Gregory D. Stein, president Dynamic Asset Management Inc.

James A Hyerczyk responds: I apologize for the error in the calculation. It is impossible to divide $1,000 by $50 and get a position of 200 shares.

In preliminary tests, I used two sizing methods. The first is the percent-- risk model. I used this one when trading a system based on a fixed stop, such as one basing a stop on entry price minus exit price. …

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