Position Sizing: All in or Average on the way up?
Which is the best way to position size for a swing trader vs a long-term investor?
When it comes to position sizing, there are two main approaches to consider. One is to go all in and buy 100% of the intended size at the beginning itself, while another is to average up as the trade works in your favor. Both approaches have their pros and cons, which we'll explore in this article.
Image: modified from Teo Jia Yi,
All in:
Taking a 100% position of your intended full size can be advantageous in that it allows you to enter the trade at the desired price point which is the perfect entry point and therefore has the minimum risk and maximum reward. Here are some pros and cons to consider:
Pros:
Higher Profitability: By taking 100% size in the beginning, and if the trade is a successful one, you have the probability of making the highest amount of possible profit as 100% of the intended capital is deployed at the lowest level.
Psychological High Ground: If your entry is correct, there is a higher probability that you will be instantly in a profit which is a better position to be in psychologically.
Simplified Position Management: With a full position, you don't have to worry about managing additional buy-ins, or averaging up.
Less Time-Consuming: With 100% size, you don't have to spend as much time monitoring the trade, as compared to an averaging up approach where you would have to keep track of the market to decide when to add more to the position.
Cons:
Increased Risk: Taking 100% size, in the beginning, can increase the risk of the trade, as the full amount of capital is at risk from the outset. If the trade goes against you, you may lose a significant amount of capital.
No Margin for Error: There is no margin for error when taking 100% size. If the trade does not work out, you may have no additional capital to allocate to other opportunities.
Emotional & Psychological Pressure: Taking a full position can create psychological pressure, especially for novice traders. The fear of losing the entire amount can lead to emotional trading decisions.
Averaging up:
Averaging up is an approach that involves initiating a trade with a fraction of the intended total position and adding to it as the trade moves in your favor.
For example, if you want to take a total position of 100K, your 1st buy could be 25% of this i.e 25K or 50% i.e 50K, and add the rest at a higher price (or multiple price points) once your 1st entry is already providing you a profit cushion.
This approach can be advantageous in that it allows you to build a larger position over time, as the trade becomes more profitable with the risk still being relatively smaller. Here are some pros and cons to consider:
Pros:
Reduces Risk: Averaging up can reduce the risk of the trade by allowing you to add to a position only as the trade moves in your favor. This can minimize the loss if the trade goes against you.
Higher Margin for error: The 1st buy with less size can be afforded a deeper stop loss and hence have a higher margin for error in our timing.
Reduced Emotional Pressure: A smaller size will generally have a smaller risk and this can translate to less emotional pressure as compared to having a larger risk.
Cons:
Requires Discipline: Averaging up requires discipline to monitor the trade and add to the position at the right time.
Time-Consuming: Averaging up can be more time-consuming than taking 100% size in the beginning, as it requires you to monitor the trade more closely to hunt for subsequent entry points.
Risk of Missing Out: With averaging up, there is a risk of missing out on potential profits if you don't add to the position at the right time.
Reduced Total Profitability: As the average buy price is higher than the 1st buy, the profit both in absolute as well as in percentage terms is lower as compared to the all-in style of sizing.
In conclusion, both approaches to position sizing have their pros and cons. Taking 100% size, in the beginning, allows for higher potential profit and simplifies position management but comes with increased risk and psychological pressure. Averaging up can reduce risk and offer a higher margin for error, but requires discipline and can be more time-consuming. Ultimately, the best approach to position sizing will depend on your trading style, risk tolerance, and market conditions.
Which system works best for a beginner?
This is a very hard question as you know trading is very personal and so is position sizing. As it is clear from above that both approaches have their advantages and disadvantages, and each trader, whether a beginner or experienced, will have their own preference.
But in my opinion, if you are a short-term swing trader, an all-in approach will suit you the best.
Whereas if you are a positional trader, or a long-term investor; averaging up with risk controlled at all times will be more beneficial and suited to the long-term psychology.
That’s all for this weekend.
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Last week”s article on, “Position Sizing Principles for monster performance”
https://sakatas.substack.com/publish/post/109970987