A 1991 Journal of Finance study by Brinson, Singer & Beebower came to a shocking conclusion about the importance of position sizing. The study is titled Determinants of Portfolio Performance II: Among other things, it found that position sizing accounted for 91% of portfolio performance.
Data from 82 large pension plans suggest that asset allocation policy, however determined, is the overwhelmingly dominant contributor to total return. Active investment decisions by plan sponsors and managers, on average, did little to improve performance over the 10-year period from December 1977 to December 1987.
In layman's terms, the study found that the size of the various positions within a portfolio - rather than the choice of the right individual stocks or the timing of the market - was by far the most influential factor in portfolio returns.
They are generally all within the same asset, so there is a lot of overlap between their portfolios, making differences such as the size of their positions even more pronounced. So it is unlikely that position sizing alone is responsible for 91% of a price action trader's returns, but the number is probably still quite high.
In both the investing and trading worlds, the overwhelming emphasis is on smart, active tactics executed by individuals. In the investing world, managers are credited with finding a security that is undervalued by the market, and traders are credited with finding that golden setup. But over a larger time frame, the impact of these individual decisions is drastically reduced.
This study was brought to my attention by trading coach Van Tharp, who calls position sizing the second most important trading skill after trading psychology. Tharp developed his own position sizing game that he plays with participants in his seminars.
In this game he gives all the players the same trades, and in his words "we will probably have as many stocks as there are participants". When he says "shares", he refers to share curves, not to different equity securities.
Depending on your trading goals, the method you use to determine how much you risk per trade may vary. In general, however, there are two main methods:
This is by far the most commonly recommended method and is widely used by fund managers and professional traders who use exness fx broker accounts. Each time you trade, you risk a fixed percentage of your account.
As a rule of thumb for individual traders, the larger your account, the fewer percentage points you risk per trade. One percent of a €25,000 account is only €250, while one percent of a €1,000,000 account is €10,000. Most retail traders do not want to risk that much on a particular trade and will usually reduce their risk per trade as their account grows.
For a variety of reasons, some traders "cap" their account size and have no desire to continue increasing their position sizes as their account grows. One reason could be the stressful trading psychology at play when risking a large amount like €5,000 or €10,000 on each trade.
Another reason could be that the trader's strategy may not be scalable, such as trading OTC stocks. This method of position sizing could also be used when losing traders who have a regular paycheck and can keep adding to their account as their losses pile up.
These traders tend to implement a fixed dollar amount of risk per trade. Based on their goals, they have set a dollar amount that they can lose on a particular trade.
