Stock Trading

How Many Positions Should You Trade?

Here’s something I struggle with — a lot:  How many positions to trade at once.  So let’s dig a little deeper.  

Sometimes I like 10. Sometimes 4. Sometimes 6. Truth is, each time I change the number of positions I trade, it changes my possible future returns.

To solve this problem, I’ll be picking a fixed number of positions I’m willing to trade and sticking with that.

Luckily, there’s a way for me to figure out what the optimum number of positions to trade is, and it all begins with my trading stats: how often I lose, how often I win, what my losses typically are and what my gains typically are.

The method I will be using to determine optimum number of positions to trade is called the Kelly Criterion.

Basically, the Kelly Criterion all comes down to this formula:

Kelly %  = Win Probability – [(1 – Win Probability)/Win Loss Ratio]

What this formula tells you is how much of your total equity to place on your NEXT trade.  Yes, you can place less than this amount, but you shouldn’t place more on the trade.

In order to use the formula you will need the statistics of all of your trades, or at least a couple years worth.  I like to make sure I use stats from at least the my last 100 trades.

So what are my stats?  Over the last couple years, here’s where I’m at:

  • Trades: 202
  • Wining trades: 102
  • Win %: 50.4%
  • Average Win: 25.31%
  • Average Loss: 12.7%
  • Win/Loss Ratio: 1.99%

The main pieces of information I care about here is my win % and my win loss ratio. From those stats I see that 50% of the time I am right — and when I am right I make 2 times as much when I am wrong.

Once I have those figures, to find out how much of my equity I should be trading on each position, I just need to plug the numbers into the Kelly Criterion. Let’s look at that formula again:

Kelly %  = Win Probability – [(1 – Win Probability)/Win Loss Ratio]

Now, let’s plug in my numbers:

Kelly% = .504 – [(1 – .504)/1.99]

When I do this I get a Kelly% of .254 or 25.4%. What this tells me is that, based on my performance stats, I should never be placing more than 25% of my equity on any single trade. I can trade less than that number if it makes me uncomfortable, but I should never trade more.

So there I have it — I should have no fewer than 4 positions on at a single time, but I can have more if I like.

4 Comments

  1. Matt Stokes December 4, 2011
    • davidjohnhall December 4, 2011
  2. Matt Stokes December 5, 2011
  3. davidjohnhall December 5, 2011

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