How to Choose Better Position Sizes

There are four key ways to improve your trading results:

• Increase the size of profitable trades
• Decrease the size of losing trades
• Increase the percentage of profitable trades
• Increase the number of trades you open (once you have a profitable Trader’s Equation)

While all of these are important, the most overlooked area is reducing the size of losing trades. Most traders focus on minimising losing trades but rarely think about decreasing the amount that could be lost on a losing trade.

Dynamic Risk

One simple way to improve this is by using dynamic risk. The amount you risk on a trade should vary depending on the opportunity. Many traders incorrectly base risk on the potential profit, but this is driven by greed. Instead, it’s more logical to use the probability of a positive outcome to determine risk. The higher the probability, the bigger your position size.

One of the big benefits of dynamic position sizing is to reduce the amount of drawdown we have. Going into drawdowns can have a negative impact on our trading, and therefore we want to reduce this as much as possible. 

But that leads to another question: how can you check if your position sizes are correlated to the probability?

Position Size Calibration

A position size calibration is where you compare your position sizes to the probabilities of the trades you’re taking. There are two data points you will need in your spreadsheet to track this:

• The probability of success
• The amount at risk in %

Now, let’s get into risk calibration. If you have a spreadsheet ready to go, this will be fairly easy as you can just reorder the columns. But here’s how to simply calibrate your position size:

1. Create a spreadsheet of your trades including probability and amount at risk columns.
2. Order your trades by the percentage at risk.
3. Compare the amount at risk with the probabilities. The higher position sizes should roughly align with the higher probabilities.

Here's an example of where the probabilities roughly align with the position sizes:

If they don’t align, adjust the risk percentages and see how performance changes. You can always duplicate your spreadsheet if you don’t want to change the original values.

If recalibrating improves performance, you need to adjust your position sizes on future trades. If it worsens performance, that can signal an issue with how you're estimating probabilities rather than the risk itself.

This simple calibration will help make sure you're risking the right amount on each trade. However, a meaningful sample size is important to draw accurate conclusions.