Selecting a position sizing option

Author: Panache

Creation Date: 12/14/2016 1:59 AM

Wealth Lab » Extensions » Selecting a position sizing option

Panache

12/14/2016 1:59 AM

I've spent a lot of time focusing on position sizers lately, and I thought I would take a minute to share a little bit of what I've learned about the pros and cons of various basic position sizing options. Eugene, feel free to chime in to the extent I've misstated anything.

Fixed Dollar - This is a good option for generating Alerts for Strategies you are trading. It isn't a good option for back testing, however. First, if the remaining equity in your account is less than the fixed dollar amount, no trade will be generated. As an example, if you have $999 remaining equity in your account, and the fixed dollar amount is $1,000, the Portfolio Simulation will ignore that trade. Is that really representative of how you would have traded in that situation? Second, assuming you have a good Strategy, and the equity in your portfolio is growing, using a fixed dollar will either result in your Strategy taking more and more positions, or leaving more and more of your portfolio in cash.

Shares/contracts - It has all the problems of Fixed Dollar. In addition, the size of your positions is going to vary widely because of the difference in price of various stocks. Imagine the difference between buying 100 shares of BRK/A and 100 shares of a penny stock.

Percent of Cash -- This sounds like a good solution to the problems with Fixed Dollar, but it doesn't necessarily do what you might expect if you have open positions when new positions are established. Let's say you have a rotation Strategy that is always supposed to own 10 positions, so you set the Percent of Cash equal to 10. The first set of trades result in each position being approximately equal to 10 percent of your starting capital. However, when one of those positions is sold, only 10% of the cash from that sale will be invested in the new position!

Percent of Equity -- This avoids most of the problems mentioned above. One thing to be careful of when using Percent of Equity is that it assumes you could actually have invested the specified Percent of Equity in each position. This can mask situations where most of your profits are coming from thinly traded stocks.

Skipped Trade Solution -- Whether or not you want to use this depends on what you want from your back test. Instead of taking the previous bar's Close, it peeks at the next bar and uses the price on that bar to size the trade. As a result, it minimizes the number of trades which are ignored because the calculated size times the next bar's price exceeded your available equity. On the other hand, if you would put in your orders before the market opens, that might be exactly how you would trade the Strategy.

Size:

Color:

Fixed Dollar - This is a good option for generating Alerts for Strategies you are trading.  It isn't a good option for back testing, however.  First, if the remaining equity in your account is less than the fixed dollar amount, no trade will be generated.  As an example, if you have $999 remaining equity in your account, and the fixed dollar amount is $1,000, the Portfolio Simulation will ignore that trade.  Is that really representative of how you would have traded in that situation?  Second, assuming you have a good Strategy, and the equity in your portfolio is growing, using a fixed dollar will either result in your Strategy taking more and more positions, or leaving more and more of your portfolio in cash.

Shares/contracts - It has all the problems of Fixed Dollar.  In addition, the size of your positions is going to vary widely because of the difference in price of various stocks.  Imagine the difference between buying 100 shares of BRK/A and 100 shares of a penny stock.

Percent of Cash -- This sounds like a good solution to the problems with Fixed Dollar, but it doesn't necessarily do what you might expect if you have open positions when new positions are established.  Let's say you have a rotation Strategy that is always supposed to own 10 positions, so you set the Percent of Cash equal to 10.  The first set of trades result in each position being approximately equal to 10 percent of your starting capital.  However, when one of those positions is sold, only 10% of the cash from that sale will be invested in the new position!

Percent of Equity -- This avoids most of the problems mentioned above.  One thing to be careful of when using Percent of Equity is that it assumes you could actually have invested the specified Percent of Equity in each position.  This can mask situations where most of your profits are coming from thinly traded stocks.

Skipped Trade Solution -- Whether or not you want to use this depends on what you want from your back test.  Instead of taking the previous bar's Close, it peeks at the next bar and uses the price on that bar to size the trade.  As a result, it minimizes the number of trades which are ignored because the calculated size times the next bar's price exceeded your available equity.  On the other hand, if you would put in your orders before the market opens, that might be exactly how you would trade the Strategy.

Eugene

12/14/2016 6:42 AM

Kurt, thanks for sharing your thoughts.

QUOTE:
This can mask situations where most of your profits are coming from thinly traded stocks.

A solution is to enable "Reduce quantity based on volume" in Wealth-Lab's Preferences (Backtest settings tab).

Cone

12/14/2016 7:53 AM

Re: Fixed Dollar
Use Fixed Dollar if you plan to spend the profits of a trading system. The idea for Fixed Dollar is not to grow the portfolio - you have a base amount to trade and you withdraw the profits to enjoy your life right now. With "Fixed" sizing, you focus on $ gains and ignore % gains.

Re: Shares/Contract
Think more "contract". If you focus on specific futures contracts (or even specific stocks), you might know that you'll always be trading only 1 or 2 contracts (or maybe 1000 shares). Also it's useful for trading a specific number of shares when using the right-click chart trading options.

innertrader

6/27/2017 2:00 AM

Where can I find out more information about the "Percent of Cash" position sizing option that Panache refers to above?

Eugene

6/27/2017 6:11 AM

Of MS123 PosSizers, one PosSizer has had an option to "Use cash", and it's Spread Equity Equally. However, said option does not work there as intended. So Kurt must be talking about his own Abacus PosSizer which he generously shared in post #28 here:

PosSizer for rotational strategy with overlapping buys and sells

Fortunately, it's precompiled so to install it follow some easy steps that I've just put in the forum thread I referred you to. Please discuss it there.