Tuesday, June 21, 2005

An argument for trading many small positions

I've been trading large quantities of tiny positions for quite a while now, but I haven't always done it that way. I like William O'Neil's methodology, but I think his advice on portfolio concentration has caused quite a few followers' stock trading efforts to end badly. If you are an IBD subscriber, you can see for yourself on the IBD message board (my handle there is "tr0p", but I haven't posted in over a month).

I want to put forth the argument that reducing trade size and increasing trade frequency carries many hidden benefits. I did not realize many of these benefits until I had traded this way for a significant length of time. I thought I would share what I've learned from my experiences and hopefully have a chance to learn from readers who want to take the time to share their outlook on this important topic.

I'm currently reading Mark Douglas's book "Trading in the Zone". This book is centered around a similar argument to the one I'm about to make. The numerous effects that follow a loss of confidence caused by equity drawdowns are the most common cause of trading failure. So in the interest of our long-term success as traders, we should seek to minimize equity drawdowns. It follows that fear-based trades and missed opportunities will also be minimized. We pull out the weeds by the roots.

When I was trading larger positions and carrying far fewer at a time, I was still doing what I do now: making trades based on things that I knew would statistically give me an edge over time, but the outcome of any specific trade was uncertain. On any given day, my odds of having a drawdown day were far higher than they are now because it takes a high quantity of trades for any statistical edge to be properly reflected in account equity. Trading with fewer positions meant that at any given time, my account equity showed a less accurate representation of what I should expect in the long run. This lays all sorts of emotional traps for the unwary trader.

It is worth rephrasing simply: "When your portfolio is composed of a larger quantity of smaller trades, you are leveraging your edge by making your account equity at each moment in time a more accurate reflection of how you will perform in the long run."

There are both good and bad side-effects to trading this way so I want to identify a few of them.

  • Higher commission. Many people trade too big because they are afraid that commission will cut too much into their profits. This is a real problem for people with small accounts. The best thing you can do is switch to a lower cost broker and trade the smallest lots you can without cutting out your edge. In Jack Schwagger's "Market Wizards" book series, many of the best performing traders in the world were asked what they thought the most common mistake beginning traders make. A common response was, "trading with position sizes that are too large for their equity."

  • Easier to hedge against market direction. More positions are being traded, causing a higher turn-over. As the weaker positions stop out, capital is made available to hedge the stronger positions while the market temporarily moves against whatever edge is being exploited. The hedging will further reduce equity drawdowns. Doing this had a profoundly positive effect on my trading.

  • In order to up the frequency of trading, sometimes the quality of the trades must sacrificed. Some edges just don't offer opportunity very often. When this is the case, the trader should seek to identify new edges that can also be exploited. Don't put on bad trades though ;-)

  • Carrying more positions requires more work. You can't be a pro without doing work, and rookies get skinned. Its up to you which you want to be.


At 9:39 AM, Blogger Michael Taylor said...

I agree with your findings. It also helps to adjust the size of your positions based upon the volatility of the instrument you are trading. Higher vol, the less size you need. Lower vol, the more size you may need to generate the same return.

At 10:50 AM, Anonymous AJ said...


Thank you for posting on my blog. I see that you also are a young trader, and like me are reading numerous books and articles to understand and devise a strong trading strategy.

I have to respectfully disagree with you. I do believe for a small time trader, commisions hurt you even if you are using the lowest price broker out there (i.e. Scottrade).

I don't go as far as William Neil and pick only 2 stocks, however I do believe 4-5 stocks is a good maximum. Also, the amount to allocate to each purchase is determined by the risk in that purchase. I would recommend a simple 25%, 25%, 25%, 12.5%, 12.5% split with the 12.5% going to the more recent offerings which offer high risk/high reward potential.

But, as always every person has to make his/her own decision. The post where I have discussed to reduce the number of stocks in your portfolio is,


If you would like to include me in your blog roll, that would be great. I am following your blog also for a while and will do the same.

At 11:32 PM, Blogger jontait said...

Thanks for the comments guys.

Michael: I know the turtle traders calculated position size as a function of volatility. System traders want to know exactly what their return will be over a statistically significant period of time, so sizing positions as a function of volatility makes sense in this context. I guess I sort of prefer having open ended potential gains, so I've found that I only add to my most volatile and profitable postions, rather than the other way around.

AJ: It looks like you've got your position sizes split into lots too. As you've described it, a 25% position would be 2 lots, and a 12.5% position would be 1 lot. If it is profitable to trade 12.5% positions after commision, why not make all trades with this size and reap some of the benefits I talked about above? You could carry as many as 8 positions, or carry the 5 that you would normally, but still have some dry powder for opportunities. For your very best positions you could carry 2 lots, but I never start this way unless I'm shorting trading the QQQQ's. When I'm carrying 2 lots in a position I tend to peel off the second lot after a bull run starts to peter out. This lets me buy dips and sell rallies all while carrying a position. It can be difficult at times, but its amazing how you can reduce your cost basis, especially when the stock starts trading in a range.

At 12:20 PM, Blogger jontait said...

For future reference, Michael Taylor wrote more about his position sizing techniques here on his blog.

At 10:45 AM, Blogger jontait said...

TraderMike has a great post on position sizing here.

Important notes from Mike's post:

Dr. Van K. Tharp did an experiment which shows the importance position sizing. In his book "Trade Your Way to Financial Freedom" Van gives the results of his testing of four different position sizing models. He tested the models on the same trading system, so the only variable was the position sizing. The simulations were run with an initial equity of $1,000,000 and took 595 trades over a 5.5 year period. The models produced drastically different results:


Equal leverage model: Each position in this model was 3% of the account equity. So at the start of the trial each position was $30,000. This method returned $231,121.

Percent risk model: According to this model positions were sized such that the initial risk exposure was 1% of the account equity. So with $1,000,000 equity the initial risk would be $10,000. So if the initial stop on a trade was $1 the system would trade 10,000 shares. For an initial stop of 50 cents the system would trade 20,000 shares, etc. This model returned $1,840,493 or 20.92% annualized.

Percent Volatility model: Positions were sized based on each stock's volatility -- the more volatile the stock the fewer shares are traded. For this trial positions were pegged at 0.5% volatility (initially $5,000 per position) -- so if a stock's average true range was $5 the system would trade 1,000 shares. This model returned $2,109,266 or 22.93% annualized.

At 11:41 PM, Blogger johnyoga said...

Hello Jon,

I agree with you. Since changing to many small positions, and scaling quickly in and out, multiple times...I don't recall a losing day.



At 12:20 AM, Blogger johnyoga said...


This reminds me of what Van Tharp had shown in his "Trade Your Way to Financial Freedom", rev 2. Take a look at chapter 13: Expectancy & opportunity. Here you (Jon) are talking about upping the opportunity. Van's "Expectunity" factors in opportunity amounts into your expectancy...notice how the expectunity sky-rockets when you massively up the opportunities (small and frequent trades). I love it! So right on!

I don't trend follow anymore, hoping and praying that the trend keeps going, and kicking myself whenever the darn trade would reverse on me and end up a loser, or have a small gain. I would now rather hit tons of singles, versus, having wide stops and hoping for home runs. Be a little mouse, nibbling at trades. Who says you can't jump right back in, once you get out with your nibbles?



At 1:13 PM, Anonymous fornls said...


You are right. I agree with both William O'Neils principles of concentrated trades and also what you are just saying.

I have lost a lot of money with concentrated trades one after another. The main problem was I was not trading with the alertness that I did before. But I concluded that it is better to start little every time we make a loss in a concentrated trade!

At 12:48 AM, Blogger SumFlow said...

The problem with small positions is when you hit one out of the ball park it does little for your overall equity.

At 9:35 AM, Blogger FranSc said...

I agree with the many comments about position sizing. I follow Van Tharp’s idea that position sizing is the part of the trading plan that allows us to reach our profit objectives. But we have to take into account that prosition sizing deppends on the epectancy of the system you’re using. So to optimize position size you have to take your system’s trades and use,at least, an optimization algorithm ( better a montecarlo simulation- bootstrapping - to see all the histories of the system).
So to summarize: you have to adapt the position size to your system.

At 4:53 AM, Blogger Khushboo Gupta said...

I am also dealing in stock market, informative blog, can you provide Stock Cash Premium service.


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