IS A ROBUST POSITION SIZING MODEL ACHIEVABLE?

Panda

7 years ago

Is a Robust Position sizing Model achievable and will it prevent us from being stopped out by whipsaws?

For the past few days that I haven’t been actively trading or probing charts, my belief about position sizing has been completely shattered.

All along, my position sizing model has been based on rigid rules that gave me the illusion of being in control yet I was not.

It is quite surprising when all of a sudden you realize that you have unknowingly been deceiving yourself by thinking that you are all about the process of trading and not the money making aspect of it.

Only to find out that some aspects when it comes to not being too concerned about the P&L, have gradually been achieved but not all.

My recent discovery has made me introspect further and therefore cast more doubt in my mind.

A mind full of thoughts which are merely deceptive illusions and nothing more.

What a terrible derangement!

Position sizing model for Beginners

Position sizing to a beginner, (I can’t talk about pros since I haven’t interrogated them on position sizing ) is all about ensuring that your risk amount is in accordance with the percentage amount of Capital. The capital one wants to allocate to a single trade, whether it’s a buy or a sell.

No folks, position sizing shouldn’t be exclusively about the money. In fact when position sizing I would prefer a model that does not make money the first priority.

I shall explain why.

To me a good position sizing model and a possibly robust one for that matter, (it has to be aggressively tested in order to conclusively determine it’s robustness.

At what point is your analysis wrong?

But for now, I would suggest that a system’s expectancy is a good indicator of the model’s robustness ) should fundamentally assess risk from a psychological point of view. And by psychological I mean market psychology (primarily greed and fear) premised on one’s Technical analysis method and market sentiment.

In short, one ought to first ask themselves; at what point will the market prove that my hypothesis is wrong?

But this is often not the case, we amatures size our positions from an emotional point of view. So we assess risk as a form of pain threshold.

We ask ourselves how much pain do I have to endure (moneywise) before my stop loss is hit? And further delude ourselves by thinking., “Well, as long as my loss is within my accepted margin (whether as a percentage or Cash). It’s okay”

I have news for you:

YOU ARE NOT FOCUSSING ON THE TRADING PROCESS fellow Amateur. So your emotions, and in this instance pain, weakens the percentage of objectivity in your technical analysis method (yes technical analysis is not 100% objective.

No form of analysis is thus far).

Pain is an emotion.

Unknowingly, you have just mixed your trading with an emotion but deceiving your mind that you are in full control of your bottom line! hence setting yourself to fail in the long-run.

Emotions Vs Trading Success

I can confidently assume that it is impossible to become a successful trader if one has not managed to control his or her emotions. (Only i can assume because i don’t know every successful trader out there maybe there are some who are uncontrollably emotional in their trading and are successful ).

Yes,I am not a risk analyst, neither am I a pro trader but I find this paragraph in Taleb’s book Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets vindicating my opinion on position sizing as a tool for determining risk;

“… it is a fact that that our brain tends to go for superficial clues when it comes to risk and probability, these clues being largely determined by what emotions they elicit or the ease with which they come to mind.

In addition to such problems with the perception of risk, it is also a scientific fact, and a shocking one, that both risk detection and risk avoidance are not mediated in the ‘thinking part’ of the Brain but largely in the emotional one (the ‘risk as feelings’ theory).

The consequences are not trivial: it means that rational thinking has little, very little, to do with risk avoidance. Much of what rational thinking seems to do is to rationalize one’s actions by fitting some logic to them…”

(The mental delusions we found ourselves in when we justify our positions sizing model that has totally been anchored on emotion).

Combine Probability with Risk

To me a good position sizing model should be able to combine Probability and Risk.

I say probability because the market is inherently uncertain and therefore prone to improbable price movements hence triggering the question.; At what point will the market invalidate my analysis and Risk? This is because with Risk we can calculate the odds of winning or losing!

(Remember Mark Douglas’s self-evident lesson: There is a random distribution between wins and losses, all you have to do is to play the odds in your favor by having an edge?

If you have not read Mark Douglas’s work and fully grasped concepts therein, stop that nonsense you are participating in called ‘learning a strategy or system’).

Sure If you actively trade, you have experienced situations in which your perfect 2% rule following stop loss has been hit. Only for the market to later turn around (and often aggressively) and play out as you had anticipated in your analysis. But by then it is too late and if you are not careful you end up chasing price and getting burned.

Conclusion

Therefore, a robust position sizing model should dictate where you put stops and the model should be based on analysis that answers the fundamental question.;

At what point will the market prove my analysis is wrong?.

The next challenge is to merge this approach with the concept of risk to reward ratio.

Interesting.