Advanced Position Sizing: The Smart, the Risky and the Downright Dangerous

Position sizing is where smart trading and self-sabotage can look worryingly similar. Used properly, it keeps you in the game long enough for your edge to play out. Used badly, it can turn a perfectly reasonable trade idea into an account-wrecking disaster. So here’s a look at the main methods — the sensible ones, the aggressive ones, and the ones that should probably be given a wide berth.

THE FOUNDATIONS: position-sizing methods every trading should understand

Stop-loss based

Basing your position size on your stop-loss distance is a non-negotiable for me*. Stake sizes should always be adjusted if your stop distance widens, to avoid inconsistent risk levels.

This means that …

Stake size = amount you’re willing to risk / stop-loss distance

So if your risk per trade is calculated as £100, and your stop distance is 50 points, then your stake should be £2.

If the next trade that comes along has a stop distance of 40 points, then the stake should be £2.50.

That way, you’re always managing your risk.

Fixed dollar sizing

Fixed-dollar position sizing means that you’ll risk a set amount per trade, irrespective of the size of your trading account. So, if you’re risking £100 per trade when your account size is £5,000 … you’ll still be risking £100 if your bank size falls to £4,000 or when your account grows to £6,000.

This kind of fixed-risk trading doesn’t allow for active compounding, which will increase your risk size as your account grows, or reduce it as your account shrinks.

Fixed percentage sizing

Compared to the fixed-dollar method, fixed percentage position sizing allows you to actively grow your position size as your trading fund increases, and this will happen automatically after each winning trade. Likewise, your position size can reduce after a losing trade.

It works by setting your risk level according to a fixed percentage of your bank – usually somewhere between 1 and 3%.

So, if your bank size is £5k and you’re risking 2%, then your risk per trade is £100. If you have a winning trade and your bank has increased to £5,200, then your risk per trade will still be 2% of that higher figure – £104.

This is the foundation of compounding – however, there are a number of different ways you can use compounding within a fixed-percentage staking method. You can find out more about them HERE.

ADVANCED METHODS: useful, dangerous, or both

Scaling in

Scaling in, or averaging up, means that you’re adding to a winning position.

This works by entering a trade initially with a smaller position size, and adding more funds to it once that trade has moved into profit by a certain amount.

This can be a useful technique for trend traders, who can add more size as a trend is reinforced. However, it’s important to note that later entries will be getting in at a worse price point, reducing the reward-to-risk ratio.

Traders who are scaling in should be very careful to avoid increasing risk. Scaling in should be used to reduce risk on the first part of the trade, not to pile into a winning trade in an unplanned way.

Structured scaling in is often referred to as ‘pyramiding’, where the largest portion of the position is taken at the start, and progressively smaller percentages of that position are added to it as the profits build.

Cost averaging

Cost averaging is the opposite to averaging up – it means adding to a losing position. And it’s a controversial method.

The idea is that breakeven levels can be reduced and reward-to-risk ratios improved on by entering at a ‘better’ price as the market moves against you.

However, cost averaging is often misused by traders who are dealing with a market that’s moving the wrong way. You enter a trade, it starts losing, but you’re still convinced that your original idea was right, so you’ll add to it.

Adding to a losing position is an easy way to end up with significant losses. Only ever do this as part of a structured entry plan – never use cost averaging on the hoof.

Drawdown adjusted position sizing

The idea here is simple: reduce your position size when you’re in a drawdown, then only increase it again when performance recovers.

So, this might look something like this …

ACCOUNT STATE	RISK PERCENTAGE OF FUND
New high	1%
5% drawdown	0.75%
10% drawdown	0.5%
15% drawdown	0.25%
20% drawdown	minimum size

The problem with this method is that it slows down recovery from losing trades, but it can also help stem the losses from a losing streak, and keep your sanity in the down times.

Equity curve position sizing

This is very similar to drawdown-adjusted sizing, but is based on how your strategy is performing more generally. You’ll use a moving average on your equity growth curve, and adjust your risk percentage based on which side of the moving average you are currently.

For example:

• Draw a 20-trade moving average on your account balance chart
• If the current account balance is above your moving average, you trade at normal risk level
• If the current account balance is below your moving average, you trade at half your usual risk level.

This can be a useful strategy health filter, but – again – will impede your bounce-back from a losing run.

Martingale sizing

Ok, now we’re getting into the very shaky territory. The Martingale system comes from the world of roulette and coin-toss betting. The idea is that after a losing position, you double your stake. The theory is that, if you lose, you bet bigger next time, so that when you eventually win, you’ll recover all those previous losses in one go.

Nice in theory, and it can work for anyone with incredibly deep pockets and nerves of steel.

In reality, losing streaks are far more common than most people realise, and position sizes, risk levels (and margin requirements) will quickly become unmanageable.

A run of just six losses quickly gets out of hand … risking £50 … £100 … £200 … £400 … £800 … £1,600 …

Martingale looks clever and lures in many investors and gamblers. But it is dangerous because it assumes you have unlimited capital, unlimited margin, and no maximum loss limit. Real traders have none of those things.

Anti-martingale sizing

This method flips the martingale method on its head. Instead of increasing size after losses, you increase after wins and reduce after losses.

So, you might have a normal risk level of, say, 1%, and increase this to 1.25% after a winner … then 1.5% after another win … but reduce back to 1.25% if you have a loss.

The principle is that risk expands during favourable conditions and contracts during poor conditions. Like the drawdown and equity curve methods, this will slow down recovery from losses, but can also slow the drawdown from a losing run. Always set a maximum percentage risk though – don’t just keep increasing it upwards on a run of winners.

Kelly’s criterion

Kelly’s criterion is a formula used to calculate the ‘optimal’ risk based on your trading edge.

The formula is:

Fraction of capital to risk = (bp-q) / b

b = RRR (reward-to-risk ratio)
p = probability of winning
q = probability of losing

There’s something very tempting about a mathematical formula that knows what you should risk on a trade … but beware!

Kelly criterion sizing can come out very high, and way too aggressive. In reality, as traders, we can’t be confident of our edge – it’s a moveable figure. Win rates change, average win sizes and loss sizes change, and market conditions can shift.

Trading just doesn’t fit neatly with the Kelly criterion.

Fractional Kelly

This is the Kelly-Criterion-Light, where you use the same equation as we saw above, but then only use a fraction of the Kelly Criterion percentage – say, half, quarter, or a tenth.

This accepts that your edge is only an estimate, not a certainty, and gives more space for uneven returns, ‘taming’ the unruly Kelly method a little.

Confidence-weighted sizing

This method is swinging the other way. While Kelly methodology, is putting your risk factors solely into the hands of the maths, the confidence-weighted method is focused more on a judgement call.

Confidence weighting is about putting more money on the best trade opportunities, and less on the weaker setups. This needn’t be subjective – you can build rules around how many trade criteria are met, and grade your trades accordingly. Is it an A* setup or a B- setup? The former might get a full-size stake, while the latter gets a half-sized stake.

I have a fundamental issue with this, which is: if you know some of your setups are A*, why bother risking your money on the B- setups at all? However, this methodology can be useful if you find yourself lured into bum trades – at least you can minimise your exposure on these.

Which is best?

So, which of these methods do I use? In most of my trading, I’m largely focused on fixed-percentage, and recalculating my stake according to the stop distance*. Within this method, I apply different compounding methods according to the volatility of my strategy and how much money I want to devote to it.

When it comes to the more advanced techniques, I’ll always advise caution. Beware of increasing your risk levels beyond comfortable levels, and NEVER apply these techniques on the hoof. Your staking strategy should be a fixed part of your trading plan, not something you invent mid-trade because the market has moved against you.

You should know exactly what you are risking before you dip your toe into the market. Not after. Not once the position is already open. And definitely not once you’re emotionally attached to the outcome.

If you’ve had success with any of these methods — or have a cautionary tale to share — I’d love to hear it in the comments below.

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*Note: for HAV Trading, although I don’t adjust my sizing according to the stop position, it is always based on the maximum possible stop distance for that instrument, so my risk will never be greater than the max.