Trading With A Variable Position Size by Tom O'Malley
Once a position has been put on, some traders will hold it at a constant size throughout the life of the trade, while other traders will vary the size. Which is better?
Once a trade has been initiated, some traders maintain a constant position size throughout the life of the trade,
while others believe they can enhance returns by varying their position size according to predefined rules. One philosophy dictates that a significant price move in the profitable direction indicates a smaller likelihood of further profitable price moves and the position size should be decreased to lock in partial profits, while the other states that prices moving in the profitable direction indicates confirmation of the trend and the position size should be increased to take advantage of further profitable price moves. Which is right?
Should the position size be decreased or increased? If the position size is to be decreased, referred to as
profit-taking , how do we choose the prices at which to take partial profits and just how much profit should be taken at each such price? If the position size is to be increased, referred to as pyramiding , should we also have some scheme for subsequently liquidating the pyramid? At what prices during the life of the trade should we increase our position size, and at what prices should we liquidate?
These questions have no obvious answers. What we need is a methodology for determining the optimal position size at every price level throughout the life of a trade. Here is such a methodology and how to apply it to real-world trading.