Stocks & Commodities V. 25:8 (32-34): Fixing The Flaws In Fixed-Fractional Position Sizing by Christian B. Smart, PhD

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 of ruin.

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.