Sunday, July 15, 2018

Position Size

One of the main ideas in traditional momentum trading wisdom is that as volatility increases your position size should decrease. This is one of the key ideas in the Turtle Trading System, for example. If you have no idea what will happen, then higher volatility likely will result in higher losses as well as higher gains.

But if you do have some ability to predict the future, that trading signal might be stronger when volatility is higher and weaker when volatility is lower. Then you will have more losing trades when volatility is low and a higher proportion of winning trades when volatility is high. This seems to be the case with my system. Higher volatility means higher risk but also a higher probability of being right. In this case, position size maybe should be constant regardless of volatility.

P.S. 22 July

I calculated the Sharpe ratio for constant position size and for strategies that reduce position size as volatility increases and and increase position size as volatility increases. The constant position size strategy has the highest Sharpe ratio confirming my intuition. The strategy with a negative correlation between position size and volatility has the lowest Sharpe ratio. The strategy with a positive correlation is in between. So, for the moment I will stick with constant position sizing.

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