What about Position Sizing?

Michael from TraderMike.net references an interesting study by Dr. Van K. Tharp about another important side of trading – position sizing.

A position sizing model simply tells you 'how much' or 'how big' of a position to take. Position sizing can be the key factor in whether or not you stay in the game or whether your gains are huge or minimal.

He tested the models on the same trading system, so the only variable was the position sizing. The simulations were run with an initial equity of $1,000,000 and took 595 trades over a 5.5 year period. The models produced drastically different results:

The worst was the baseline model which just bought 100 shares of stock whenever a signal was given. That model returned $32,567 or 0.58% annualized.

Fixed-amount model: This method traded 100 shares per $100,000 in equity. It returned $237,457 or 5.75 annualized.

Equal leverage model: Each position in this model was 3% of the account equity. This method returned $231,121.

Percent risk model: According to this model positions were sized such that the initial risk exposure was 1% of the account equity. This model returned $1,840,493 or 20.92% annualized.

Percent Volatility model: Positions were sized based on each stock's volatility -- the more volatile the stock the fewer shares are traded. For this trial positions were pegged at 0.5% volatility. This model returned $2,109,266 or 22.93% annualized.

I personally think that percent risk model is one of the best strategies to use, with a few exceptions.

Read further:
Trader Mike: Position Sizing