Position Size and Market Volatility - Trend Traders

chumbucket · Nov 9, 2007

Given this statement....

"Position size must be calculated based upon market volatility and assigned per position risk"

The statement and many like it have been published by "successful" or seemingly sucessful trend following organizations and individuals.

My question is how?
Does greater volatility when a position is entered mean that one should decrease size or increase size?
If my methodology is following a daily chart, do I consider some relationship with daily volatility or rather weekly or monthly?
If I get a signal during relatively low volatility, alerting me to a possible breakout is it more advantagous to add to these positions?

I don't want to debate the statement here, just try to better understand assuming that it is an accurate statement. I realize the answers are unique to the individual trading methodology, but what are other traders here doing that is successful in relation to position sizing, risk and market volatility.

ronblack · Nov 9, 2007

Quote from chumbucket:

Given this statement....

"Position size must be calculated based upon market volatility and assigned per position risk"

My question is how?

Position size = (percent risk x current bankroll) /( n x ATR)

ATR = Average True Range for a period of k bars. Usually k = 14

n = a multiplier (usually equal to 2 meaning that you exit if the price moves two average days against you)

For trend following maybe you want to use n = 5 or even n = 10.

I am a swing trader and I use k = 14 and n = 2.

For percent risk I use 2% to 4% maximum.

Ron

trend_guy · Nov 9, 2007

- a simple way to measure volatility is with ATR, described above

here is a simple example...

you have a 100K portfolio and are willing to risk 1% per position

100K x 1% = 1K

ATR(average range) = 5

you set an initial stop of 2ATR, 2 x 5 =10

$1000 portfolio risk / $10 trade risk = 100 shares

therefore with an ATR of 5 you can buy 100 shares.

if the ATR was 2 you could buy 250 shares.

in the above example... as the volatility increases your position size decreases.

MGJ · Nov 9, 2007

I recommend extreme scepticism when told what you "should" do or what you "must" do.

Little anecdotes like (this one) serve to remind me that there are a million ways to trade profitably, some of which appear highly unorthodox to outsiders.

trend_guy · Nov 10, 2007

I've heard many traders preach that same thing as LeBeau, regarding how entries really aren't that important. Personally, I don't buy it, I think both entries and exits are very important... it's hard to make big money without good entries... in my opinion.

SuperVolatility · Nov 10, 2007

How to determine ATR?

For example EMC, trading 1 or 5 min bars what is ATR? Or even trading daily bars?

Thanks.

chumbucket · Nov 10, 2007

Thanks everyone. This is very helpful. I have another question. Are we all assuming that high volatility is a signal to reduce risk? Have you all done studies to prove this theory? How can we tell that we should not be increasing our size, risk when volatility is high or extremely high?

kiwi_trader · Nov 10, 2007

Quote from chumbucket:

Thanks everyone. This is very helpful. I have another question. Are we all assuming that high volatility is a signal to reduce risk? Have you all done studies to prove this theory? How can we tell that we should not be increasing our size, risk when volatility is high or extremely high?

You missunderstand.

High volatility is increased risk.

chumbucket · Nov 10, 2007

I guess I am misunderstanding....

In the examples of position sizing above....as the ATR increases this reduces the recommended position size. Is this correct or am I doing something wrong?

If I am correct, then I am trading fewer contracts when volatility (measured by ATR) is higher.

Hook N. Sinker · Nov 10, 2007

Quote from chumbucket:

"Position size must be calculated based upon market volatility and assigned per position risk"

I find lots of position sizing rules can show profitable outcomes.

Sometimes I use average true range (ATR) as a way to adjust position size so that I buy more shares when price is say $ 1 / share and fewer shares if price is $ 400 / share. ATR of a $ 1 / share stock might be $ 0.10 / share, ATR of a $ 400 / share stock might be $ 10 / share. So I might buy 100 x more shares at $ 1 / share than I buy if the price is $ 400 / share.

Sometimes I calculate position size using a percent of stock price.

Some price histories may span 30 years. A price history may record many stock splits that make early price data appear about $ 1 / share and recent price values may be much greater.

You might obtain trading simulation software and perform some studies yourself. The price of simulation software is likely less than the cost of a few trading losses.

Perhaps the most important thing that I learn from trading models is to ignore the one to three month panic and hysteria such as the bearishness associated with the current stock market. In other words, accept the volatility. If I do not accept the volatility, then I do not make the money.

You might notice that stocks continue to appear on the 52 week high list. Not everything is trading at lower prices. The panic and hysteria in stocks does not seem to affect every stock equally.