What do Money Management, Bet Sizing, and Position Sizing All Have in Common?

“The class of those who have the ability to think their own thoughts is separated by an unbridgeable gulf from the class of those who cannot.”
Ludwig von Mises

Money Management has many names: asset allocation, position sizing, bet size, portfolio heat, portfolio allocation or even risk control. It is terribly important for long term success. It is at the root of all trend following winners.

Q. Why exactly is money management so important?
A. Determining your bet size is key. If you don’t know how much to buy or sell (your bets) at all times you are in trouble. If you start with $10,000…is your first trade 2% of that? 10%? What is the number? You must know it.

Q. What do you mean?
A. Most traders believe that money management is simply where you place your stop. A stop alone is one part of a trading system, it’s not money management. You can buy any number of programmed systems for TradeStation (we don’t recommend TS) that all tell you they have money management built in, but all they really do is give you a stop. The key question of money management must focus on the “how much” question, not the timing of when you enter or exit. Worry about the optimal amount to trade or how much to buy or sell — those are the key questions for all traders.

Q. Money management yeah whatever – I want to know about trading system percent accuracy. What is it?
A. You are on the road to the poor house! Percent accuracy is fools gold. System 1 below looks more impressive than System 2 if we use your focus on accuracy. 85% accurate, you can’t go wrong right? Wrong:

System One

Percent Win: 85%

Percent Loss: 15%

Avg Profit: $500

Avg Loss: $1,500

Expectation per trade: $200

System Two

Percent Win: 45%

Percent Loss: 55%

Avg Profit: $1,500

Avg Loss: $500

Expectation per trade: $400

The examples above show how and why the desire to be right kills many traders. They focus on % winning trades and % losing trades instead of proper bet size (money management). System 2 is the better system. It makes more money. System 1 is all about ego (and long term losing). System 2 is all about math.

More on Accuracy Grails.

Q. Is there a prerequisite market condition for trend following to work?
A. Trend following makes the most money in trending markets, but that is not something you can predict. It is a false notion that you can pick the trading approach for any one period of time. You would end up jumping around looking for the Holy Grail going from system to system. The idea of trend following is to make big money on big trends, but preserve capital and avoid losses in non-trending periods. Jump around and you are destined to lose.

Q. How would you apply trend following to a less developed stock market in the Far East where dissemination of price-sensitive information tends to be less efficient leading to irrational price movement?
A. People attempt this same argument here in the States. Why care what a market does? Trend followers just follow along. And let us ask what is ‘irrational’ defined mathematically? Saying a market is ‘irrational’ hints at lack of an ability for you to predict it. No prediction is used with trend following.

Trend Following Products

Review trend following systems and training: