An Introduction To Position Sizing, Risk And Variance
PreviewSome traders could already be profitable, but their position sizing is stopping them from achieving better results. In this lesson, we will start digging into position sizing and risk management, and we will show you how you can find out how position sizing is impacting your performance.
Position sizing filters
Each tab in your Edgewonk journal has a filter that allows you to filter your trades and performance based on your position size. Here are some tips on what to look for when using the position size filter:
- Equity graph: do you see differences in volatility for different position sizes? Do the swings change?
- Tiltmeter in equity graph: does your Tiltmeter differ between low and high-risk trades? Do you make more mistakes or are more sloppy?
- Trade Management: Do you mismanage your trades when the size of your trades changes?
- Holding time: Do you close trades too early when the risk is higher?
- Simulator: How does the volatility change based on risk in your trading?
Now we want to get into the details of how math and statistics impact your performance and what role position sizing plays here. But don’t worry, you don’t need to know much about math – we will keep it simple and give you a lot of examples along the way. If you are not interested in this mathematical explanation, you can proceed to the next lesson where we will walk you through a practical example.
Losing streak and account drawdowns
First, let’s start out by analyzing how likely certain losing streaks are.
For example, a system with a winrate of 60%, you still have a chance of 1% that you’ll encounter 5 losing trades in a row. 1% does not sound a lot, but if you have a few hundred trades a year, you will almost certainly have several losing streaks of 5 or more trades.
With trading method with a winrate of 40% (which is what many professionals have), you even have an 8% chance of 5 losers in a row. This means that you’ll probably have 5 or more losers in a row every few weeks/months.
| Consecutive losses | |||||
| Winrate | 1 | 2 | 3 | 4 | 5 |
| 70% | 30% | 9% | 2.70% | 0.81% | 0.24% |
| 60% | 40% | 16% | 6.40% | 2.56% | 1.02% |
| 50% | 50% | 25% | 13% | 6% | 3% |
| 40% | 60% | 36% | 22% | 13% | 8% |
The probability of consecutive losing trades based on winrate
Now let’s see what this means for your risk. If you risk 3% per trade, you will lose 14.1% of your account when you have 5 losers in a row which is quite a lot when you think that you’ll have such drawdowns a few times per year. If you even increase your risk to 5% per trade, you will have a drawdown of 22% after 5 losses – that’s almost one-quarter of your account!
It’s important to understand here that 5 losers in a row will happen even to the best traders – it’s a mathematical certainty. But if you combine this with a very high position size, you will inevitably run into large drawdowns.
| Consec. losses | 1% per trade | 3% per trade | 5% per trade |
| 1 | 1.0% | 3.0% | 5.0% |
| 2 | 2.0% | 5.9% | 9.8% |
| 3 | 3.0% | 8.7% | 14.3% |
| 4 | 3.9% | 11.5% | 18.5% |
| 5 | 4.9% | 14.1% | 22.6% |
| 6 | 5.9% | 16.7% | 26.5% |
| 7 | 6.8% | 19.2% | 30.2% |
| 8 | 7.7% | 21.6% | 33.7% |
| 9 | 8.6% | 24.0% | 37.0% |
| 10 | 9.6% | 26.3% | 40.1% |
account loss during a losing streak
An introduction to the Edgewonk Simulator
The Edgewonk Simulator is the most efficient way when it comes to seeing the impacts of risk and position sizing on your account development. The Simulator takes your current performance and simulates the potential outcome of the next 500 trades, based on your metrics.
By applying the position sizing filter to the Simulator you can see immediately how different levels of risk impact your performance and account volatility. You can also manually input performance metrics and simulate potential future outcomes to get an even better feeling for how the metrics work together.
In the next lesson, you’ll learn everything about the Simulator.
