The Science and Art of Position Sizing

Abstract

This paper will discuss position sizing based upon three different models: Portfolio theory, Kelly betting and the Alternative investment model which represent the 1% rule. We will then construct a simple trend following trading model where an investor is faced with a hefty 88% chances of a losing trade. This paper shows than an investor can overcome such obstacle by engaging in systematic risk management and by equalizing risk over changes in expected return. We have also shown that an investor’s return is an increasing function of how long he stays in the market rather than how much risk he takes on.

Keywords: position size, trend following, risk management

JEL Classification: G00, G1