Definition
Position sizing is one of the most critical risk management decisions. Methods include fixed dollar amounts, fixed percentage of portfolio, volatility-based sizing (adjusting for asset risk), and Kelly criterion (mathematically optimal sizing). Proper position sizing ensures no single trade can catastrophically damage the portfolio.
functions Formula
Kelly % = (bp − q) / b
Kelly: b = win/loss ratio, p = win probability, q = 1-p
lightbulb Example
Portfolio is $100K. Using 2% risk rule with a stop loss 5% below entry: position size = $100K × 2% / 5% = $40K. This limits each trade's maximum loss to $2K (2% of portfolio).
verified_user Key Points
- Critical risk management decision
- 2% rule: risk no more than 2% of portfolio per trade
- Volatility-based sizing adjusts for asset risk
- Kelly criterion gives mathematically optimal size