What is Position Sizing ?
Intro
The greatest way to win the game of finance isn't picking the next stock that's going to win, it is by constructing a portfolio structured around how much risk you're willing to take. Position sizing, the component of risk management that helps you decide how much of an asset to buy, should be carefully calculated to prevent overexposure to dangerous assets and let the winners compound.
Plan For The Worst
Before buying anything, you must take into consideration the risks at hand.
The risk of ruin, the probability that your losses will be so severe that recovery becomes practically impossible, should be considered before making any purchase of an asset. The main mathematical property that amplifies risk of ruin is loss asymmetry: recovering from a loss requires a disproportionately larger percentage gain.
The easiest example of loss asymmetry is that a -30% loss requires a +43% gain, or a -50% loss requires a +100% gain to recover fully from losses. The deeper the hole, the steeper the climb, which is the entire reason position size matters.
Position Sizing Methods
Every method I'll explain is defined by whatever is being held constant.
Fixed dollar position sizing is when you invest the exact same dollar amount into every position. Fixed dollar investing could look like putting $1,000 into every stock you buy, regardless of the stock or the size of your account. However, as your portfolio experiences changes, this methodology becomes flawed.
Fixed dollar position sizing fails to account for the size of the portfolio and the volatility of the securities within it, so the same $1,000 can be trivial in one name and reckless in another.
Fixed fractional position sizing is when you risk a constant amount of equity per trade. For example, if your portfolio is $100,000, each trade would risk around 1% of that $100,000. As your account grows, fixed fractional position sizing allows for larger positions. Conversely, if your account shrinks, your position sizes will reduce accordingly.
That self-correction is what makes fixed fractional position sizing safe, but staying conservative also caps how fast you compound, so you leave some growth on the table in exchange for survivability.
Fixed Weight position sizing is when you allocate an identical percentage across the whole portfolio. For example, this would be a portfolio carrying 10 stocks worth $100,000, roughly $10,000 each holding. However, stock prices fluctuate, so maintaining the weight of the portfolio requires periodic rebalancing: trimming the winners that have grown past 10% (in this instance) and adding to the positions that have fallen below it.
This method works best for investors who don't have strong conviction differences between their holdings and want to avoid concentration risk. Because it forces you to sell appreciated positions and buy depressed ones, it imposes a disciplined "buy low, sell high" mechanic. It makes a sensible default for retail investors, as most of the time we lack data (and knowledge) to rank positions by expected return or risk.
Comparing Position Sizing Strategies
