ES Tuesday 10-25-16 : Hot Topic

Size of Position

The influence of position size on profits

Following on from the Time of Day and Target Size article we look at how one strategy can perform differently for two traders because of the size of the positions that they trade. Trader Ace is a 2 contract trader and Trader B is a 1 contract trader.

Trader Ace Trader B
Target 1 5 points -
Target 2 10 points 10 points
Stop Loss 2 points 2 points
% winners (all winners go to both targets - Trader Ace has no partial winners) 20% 20%
Expected Points per 5 trades -0.5 points (7.5 x 1 - 2 x 4) 2 points (10 x 1 - 2 x 4)

Trader Ace runs a successful trading room and has invited his friend Trader B to join him in his room and share with him his star strategy that has been making him money for years. Trader Ace trades twice as many contracts as Trader B and always takes off half of his position half way to the target and then the balance at the target. This money management plan works very well for all of Trader Ace's other strategies so he's going to stick with this method of money management and just use Trader B's entry calls and target. He adds his own half target to Trader B's strategy.

As you can see from the simple example, Trader Ace is losing money. This isn't for any other reason than the fact that he needs to take his entire position to the target in order to make up for the losses that happen 80% of the time.

This is obviously a hypothetical situation but it illustrates the point that a trader that has the choice to take partials at different target levels will have different results to a trader that has fewer options because of the smaller size that they trade. I presented the example here to demonstrate that a good strategy for a small one contract trader is not necessarily good for a larger trader that wants to use multiple targets. If you are a successful one contract trader you may find that you are not as successful when you move up to 2 or more contracts for exactly this reason.

This example, however, is usually shown in reverse and can be presented to show that Trader Ace will be more profitable by taking profits at multiple targets than Trader B who can only take profits at 1 target because his 1 contract cannot be subdivided for multiple contracts. This is the situation that often happens in trading rooms where a good trader using multiple targets is shadowed by smaller traders trading 1 or a few contracts.

This should caution traders that are shadow trading traders who can apply very different money management strategies because of their size. Shadowing these larger traders will not necessarily make your trades profitable in the long run because your size will work against you.

How do you know if you can trade 1 (or a few contracts) successfully alongside a much larger trader and use the same strategies? One way to test this is to do a side-by-side simulated or paper trade of both money management strategies. You can track this on paper or in a spreadsheet and I know that some trading platforms also allow this. Track Trader Ace's trades and track your trades on paper and see if you would have been as profitable after a week of trading using your smaller contract size compared to his larger contract size. You may discover that your trades produce losses because you are undercapitalized. On the other hand, you may serendipitously discover that taking fewer targets improves your profitability and would also improve Trader Ace's profitability. If this is the case then sell him your money management strategy.