Position sizing – a better method than fixed fractional

Fixed fractional is the standard position sizing method recommended to most traders. With this method the trader risks a fixed percentage of their trading capital on each trade. Typically this percentage would be 2%. The trader would calculate the risk of the trade in pips, convert that to dollars and then divide the figure into 2% of trading capital to get the number of contracts to trade.

This is a good workaday solution however it tends to result in somewhat slower equity growth than can be possible with many other methods. For instance with a small account risking such a small percentage of the account it may take a long time before one can move from  say one contract to two contracts  or even one  dollar per point to two dollars per point. We want equity growth to go geometric as soon as possible so this method is somewhat of a drag on that escalation.

One simple variation on this method that does show dramatic improvements in equity growth is what is known as the profit risk method. This is simply a slightly turbocharged version of fixed fractional. It still remains consistent with one of the undeniable rules in trading which is that you must look after your own capital and treat it as gold dust. This is because  if you lose that capital you’re out of the game. As that old traders saying goes “the markets will always give you more opportunities but they will never give you more trading capital”.

The profit risk method essentially splits your  trading capital into two portions and trades each portion differently. The first portion is your own trading capital that you start with and the second portion is any profits that you make. It then applies two different percentages to those two trading pots to calculate how much to risk on the next trade. You will use a relatively conservative percentage on your own capital but a more aggressive percentage on your trading profits portion of total capital.

Let us say that you started trading with $10,000 and have now built that up to $30,000.  With the profit risk method on each trade you may elect to risk 2% of your starting capital but 6% of your profits on each trade. So in the next trade you would risk $10,000 * 2% + £20,000*6% = £1,400.

Whilst this would appear to be a relatively small change to standard fixed fractional trading it does over time produce  truly dramatic improvement  in equity growth. Using this method  is entirely consistent with good trading practice as you are still being extremely cautious with your own capital but quiet correctly being more aggressive with any profits that you make.

This is just one simple way of improving on the standard fixed fractional position sizing method. There are several other much more aggressive position sizing techniques that one can use that are far superior even to the profit risk method. All of these more aggressive techniques are covered during  the one-to-one private training sessions.