Position Sizing
Rules for how much capital to allocate per trade or asset (equal weight, risk parity, Kelly, etc.).
Definition
Position sizing is the set of rules that determine the notional or dollar amount (or weight) allocated to each position in a portfolio.
Why it matters
- Risk control: Oversizing leads to blow-ups; undersizing leaves return on the table.
- Consistency: Same edge with different sizes can produce very different outcomes.
Common approaches
- Equal weight, equal dollar, equal risk (vol-weighted), inverse vol, Kelly fraction.
- Max position and max sector limits to avoid concentration.
Common mistakes
- No max position limit.
- Ignoring correlation (effective risk is higher when positions are correlated).
- Using point estimates without considering estimation error.