Fixing The Flaws In Fixed-Fractional Position Sizing by Christian B. Smart, PhD
Fixed-fractional position sizing is a time-tested method for
money management, but in the long run, it will never achieve
system expectancy. Here’s how you can fix this flaw.
Fixed-fractional position sizing is a popular
and time-tested method for money management.
In the strategy, a fixed percentage of
equity is risked per trade. The formula is
given here as:
Amount risked per trade = Equity * f
where f is the fixed percentage of equity risked per trade.
Fixed-fractional money management is an intuitive method
in which bet size increases when equity increases and bet size decreases when equity decreases. This form of money management
is conservative in that it dramatically decreases risk
A concept related to money management is system expectancy.
A system’s expectancy is the average, or expected,
amount of money an investor expects to make per dollar
risked. For example, a trading system with a winning percentage
of 40%, whose average win is equal to twice the average
loss, has an expectancy approximately equal to 0.40 * 2 – 0.60
= 0.80 – 0.60 = 0.20.