Position Sizing and Money Management for Traders

by VanTharpTrading on Nov 17, 2010

http://www.vantharp.com
http://www.tharptradertest.com

Van Tharp talks about position sizing.

Money management is a very confusing term. When we looked it up on the Internet, the only people who used it the way that Van was using it were the professional gamblers. Money management as defined by other people seems to mean controlling your personal spending; giving money to others for them to manage, risk control, making the maximum gain, plus 1,000 other definitions.

To avoid confusion, Van elected to call money management "Position Sizing." Position sizing answers the question, "how big of a position should you take for any one trade?"

Position sizing is the part of your trading system that tells you “how much.”

Once a trader has established the discipline to keep their stop loss on every trade, without question the most important area of trading is position sizing. Most people in mainstream Wall Street totally ignore this concept, but Van believes that position sizing and psychology count for more than 90% of total performance (or 100% if every aspect of trading is deemed to be psychological).

Position sizing is the part of your trading system that tells you how many shares or contracts to take per trade. Poor position sizing is the reason behind almost every instance of account blowouts. Preservation of capital is the most important concept for those who want to stay in the trading game for the long haul.

Imagine that you had $100,000 to trade. Many traders (or investors, or gamblers) may just jump right in and decide to invest a substantial amount of this equity ($25,000 maybe?) on one particular stock because they were told about it by a friend, or it sounded like a great buy; or perhaps they decide to buy 10,000 shares of a single stock because the price is only $4.00 a share (equating to $40,000).

They have no pre-planned exit or idea about when they are going to get out of the trade if it happens to go against them and they are subsequently risking a LOT of their initial $100,000 unnecessarily.

To prove this point, we’ve done many simulated games in which everyone gets the same trades. At the end of the simulation, 100 different people will have 100 different final equities, with the exception of those who go bankrupt. And after 50 trades, we’ve seen final equities that range from bankrupt to $13 million—yet everyone started with $100,000 and they all got the same trades. .......

http://www.iitm.com/sm-position-sizing.htm

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