When running multiple strategies, should position size be changed based on the drawdown of individual positions, systems or the system as a whole?

This question was originally posted on Quora. Something really cool dawned upon my drunken stupor lately and i modified a chapter in the book. By group of systems, let’s assume you refer to strategies.

One-size-fits-all position size algo is a form of laziness

Most people have a one-size-fits-all position sizing algorithm across all their strategies for the long and short side, through drawdown and run-ups. That is as efficient driving the same car in the same gear uphill, downhill, downtown or on the highway.

Two possible explanations for that:

  1. hmm, never really thought of that
  2. you gotta soldier on through the skinny days to reap the fat days.

Money is made in the money management module

How you bet determines how much you make. Over a small data sample, stock picking might make a difference. Over a complete cycle where style goes in and out of favor, position sizing is the main driver of performance.

Now, let’s reframe the question: Should position sizing depend on the equity curve, the strategy, the side (Long/short) and/or the individual security traded?The answer is all of the above.

The position size that you are about to take should reflect:

  1. how well you are doing at the moment in general: The idea is to take more risk in run-ups and less during drawdowns
  2. the strategy you are about to trade: Different strategies warrant different position sizing algos or at least different values for the variables. Example: high win rate mean reversion and low win rate trend following etc
  3. the side you are trading on: long or short, they have different win rates and expected pay-offs
  4. the instrument: let’s say you got 3 false positives in a row, you might want to take less risk. This is an individual penalty ledger. Conversely, if you ladder in or scale up, you might want to depreciate risk for any additional position

Putting everything together

This gives a pyramid like this

Now, the first layer is the risk adjusted account balance. I will not go into details on how you calculate this, but in practice either your equity curve or your account balance would do.

Drawdown module

Then, You want to stick a drawdown module, that would reduce the capital allocated based on your current balance versus the peak. Simply said, if You are in a -5% drawdown, you might want to allocate only 50% of the capital you would normally allocate. This drawdown module has a shape like this:

For reference, the black line is what Millennium Partners does to managers: they reduce the book by half after a -5% loss. The green line is a conventional arithmetic proportional reduction. The red is my own take on this concept. Formula is proprietary

Strategy and side stats:

This means you need to keep a record of the stats for each position sizing algo you use for each strategy on each side. This is still at the portfolio level. Example: let’s say currently trend following has 40% win rate on the long side and 20% on the short side. Mean reversion has 60% Long and 30% short etc.

This tells you which strategy works on which side etc.

Now, let’s move down to the individual instrument level

Penalty ledger and game theory

Now, this is where things get really interesting. Some market participants like to use game theory for stock selection. I believe game theory is better suited for position sizing.

The difference is: using game theory for entries is a binary choice: either in or not in. There is no learning there because you do not keep stats on the choices you did not make. Unless you are a creepy stalker, you do not keep tabs on the women you did not marry…

At the security level, you have stats over how well each position has performed. Reward those that did well and punish those that did not is a simple elegant heuristic. This is where game theory really works well. The algo we use is a child playground game, worked for centuries. It has consistently defeated sophisticated game theory algos in iterative contests. You want to know which algo it is, go pick up your kids a bit earlier today.

Pyramid depreciation

Adding tranches to an existing position is called scaling in/laddering/pyramiding. This is a staple for trend followers. Now, trends are born, grow, mature and eventually die, a bit like believers in the Efficient Market Hypothesis. So, you need to depreciate risk as you add new tranches. A simple way to do this is:

depreciation rate = 1/(1+n),  with n=0 before you enter your first position

Now, multiplication has this wonderful property called transitivity, that allows us to blend everything together in a condensed formula that looks like this:

Size = Capital * drawdown module * penalty ledger * depreciation * f(strategy stats, side stats)

Trade rejection, asset allocation, and regime change

And the best for last. Once you grind your variables through the above formula, out comes a position size. then, you want to have a trade rejection hurdle. Below x% or x(MV) position size, trade is rejected.

What it says is simple. One of the ingredients in your basket is rotten:

It could be either: 1) you are in a drawdown, 2) the strategy that is out of favour now, 3) the side is not working, 4) the instrument itself has a frustratingly low win rate, 5) You have already reloaded a few times. Whatever the reason, this is not a fat pitch, so you want to keep your powder dry.

This has implications on asset allocation and regime change. Let’s say you run a multi-strat book. Your amount of capital is finite. So every position has to compete for cash.

By systematically weeding out the ones with low score, you end up privileging the strategy that works the best under the current regime. This means you would take a lot of mean reversion trades in a sideways market, while the trending algo would suck air. Then, as Ms. market feels like trending, your trending positions would lift the overall trending strategy stats and get a better allocation. Now let’s say the trend would be down, your long trending stats would deteriorate and the algo would be naturally more selective.


Position sizing is a vastly under-appreciated topic, despite being the primary driver of long-term returns: it is not what you pick that makes the difference, it is how big you size them. Position sizing can achieve much more than just delivering returns.

Some of the thorniest issues for multi-strat managers are asset allocation and regime change. Well, your position sizing algo can do the heavy lifting for you to allocate between strategies and navigate regime change.

For more on the topic of position sizing, check this blogpost on Quora: Simplified-Convex-Position-Sizing-Something-Your-brain-can-trade-Part-II



Let’s reframe the question: can You be a top pro athlete while having a 9 to 5 job?


Automated trading is the hardest discipline

Automated trading is by far the hardest way to trade. If You think of the markets as driving a Formula 1, then automated trading is being in the cockpit without a steering wheel, brakes or accelerator, only adult size diapers.

Think about it logically:

  1. You compete against people who stare at the screen all day long. They can intervene anytime. Your algo will not.
  2. You need to have considered all contingencies. Things will go wrong. Rather than adding complexity, special cases and all kinds of savant fragility, You need to reach the essence of simplicity. It took Picasso 30 years to draw a face in three lines
  3. False positives: eyeballing charts in hindsight is one thing, getting the algo to distinguish false from true positives is another
  4. Time heals everything, after the fact. People who have not thought their system through usually default to longer timeframes. In hindsight, it does work. In practice, everyone is an investor until they lose 20%

Trading is a business

If You treat it as a hobby, remember that You compete against people who treat it as a business. Only a small elite survives. So, as a part-time trader, how do You expect to beat those who have devoted their lives to the craft?

This post originally comes from a question asked on Quora

How do I get better at trading?

How do I get better at trading? by Laurent Bernut

Answer by Laurent Bernut:

Hope is a mistake”, Mad Max, post apocalyptic road poet.

3 declinations of the same principles: process

A. Trading edge is not a pretty story , trading edge is a number

Every strategy ever traded boils down to this formula:

Gain expectancy = Win% *AvgWin% – Loss%*AvgLoss%

Your survival only depends on how You can tilt the distribution. Regardless of the asset class, there are only two styles: mean reversion and trend following.

  • Open mindset: there is a nugget in everyone’s story
  1. Read the classics: Lefevre, Schwager, Covel, Van Tharp, Loeb
  2. Podcasts: Michael Covel, Andrew Swanscott, Barry Ritholtz
  3. Investment newsletters are to investment what mangas are to literature, Unsubscribe, no exception
  • Stock picking is vastly overrated
  1. Plain vanilla fundamentals is not enough: 3/4 of professional managers underperform; over 3/4 of them claim to be fundamental stock pickers
  2. 90% of market participants focus on stock picking and entry. 90% of market participants fail. Causality and correlation: unsubscribe from all newsletters
  3. never enter w/o an exit policy: Once in a position, there is 100% chance You will exit. W/o exit plan, 90% chance the market has sth nasty in store for You
  4. Money is made in the money management module. The single largest performance discriminant is bet size: process and math

B. Portfolio management process

  • Risk is not a story in China, Risk is a number

Risk is not a story. Risk is not a high Sharpe ratio or low VAR. Risk is how much You can afford to lose per trade and cumulatively. Whatever You think your risk budget is, divide it by two. By the time You have lost half your budget, You will be a different person, gripped in cortisol and CRH, paralysed by fear.

  • Write strict investment guidelines: risk, exposures, objectives

“People live up to what they write down”, Robert Cialdini. Formalise your process in writing. Execute. Simplify. Running a portfolio w/o strict guidelines is like building a house w/o a plan

C. 90% of trading is mental, the other half is solid math

Above all else, any trading system is worthless w/o the right mindset: process over outcome

Examples of outcome vs process:

  1. Stop loss override: ego over process
  2. Close a position too early clear trading plan: outcome vs process mindset
  3. Too big/small bets: euphoria/depression over process
  4. Focus on performance instead of plan execution: outcome over process
  5. Mood swings depending on performance: outcome vs process

Being right is not being profitable (outcome). Being right is following the plan (process)


This is an “avant-gout” of the book to come. On the short side, the market does not cooperate. Open and process mindsets are the two keys to survival

How do I get better at trading?

#Quora: How should I manage a client’s portfolio if he wants a 8-10% return and no negative years worse than -5%, and has a starting amount of $2…

How should I manage a client’s portfolio if he wants a 8-10% return and no negative years worse t… by Laurent Bernut

Answer by Laurent Bernut:

Experience has taught me that people like this are a plague. They are not risk adverse. They are conservative to the point of being risk seeking: by refusing to accept moderate waves of volatility, they invite left tails tsunami. If You cannot afford to turn his money away however, here are the formulas

A. Psychology of conservative people

If You can’t stand losing, then You shouldn’t play. When they say they are willing to accept modest returns as long as You don’t lose much, what they mean is they do not want to lose at all.

Conservative is not synonymous with risk adverse. They are opposite in fact. Risk adverse means You have articulated and pieter_bruegel_the_elder_-_the_parable_of_the_blind_leading_the_blind_detail_-_wga3512quantified your risk appetite. Conservative means You are afraid of taking any risk. You are ready to discount your ambitions to the point they will be met with certainty. Kodak, Nokia were risk adverse…

It also means they are afraid and think everything is risky. It is your responsibility to educate them on risk. Do not step into dissertation mode about China, the Fed, Venusians landing in Central Park and Yoyogi park in Tokyo (i will sacrifice myself and volunteer if those sexy Venusians want to perform tests on my body). Risk is not a story, risk is a number.

Secondly, if You deliver, they are likely to demand more over time: 8–10% turns to 10–12% etc. Two reasons for this: you will be put in competition with other managers who promise they can deliver better with the same risk. Since your returns are underwhelming, You will be in constant competition. Secondly, and this is more insidious, they become overconfident. Since they believed everything was risky but now are making money, and they still don’t understand risk, they turn euphoric, literally drunk on testosterone and dopamine. They are laughing their way to the bank until the day you start losing again.

B. Market’s money

The strategy is to start small with minimum risk and increase gradually as you generate performance. Then, before year end, you reduce risk so as to start the new year afresh.

Many people do the gradual increase well, but forget about the decrease. Investors think in calendar years.

Example: first quarter, you generated 2%. You can now increase risk by x% of your gains (10–33%). So instead of risking 0.10% per trade, you would risk, 0.12% and so on and so forth.

Comes November, You are currently risking 0.20% per trade. Now, it is time to de-risk down gradually down to 0.10% so as to start January with a low risk, low concentration portfolio, ready for the new year. Remember: in the investors mind, January is the beginning of a new year, not the continuation of last year’s market.

C. Risk:“how much is enough?”, Steven Seagal, obese mythomaniac

You will often read that you should not risk more than 1–2% of your capital per trade. This does not mean position size, but equity at equity at risk. In your case, if you apply that rule over 5 stocks, one bad month and game over for good. So, get a better bad idea …

What is the maximum risk You can afford on each trade? This is one of the thorniest questions in financeI have pondered that question for years, until one day i came up with a simple elegant solution. Input variables

  1. Drawdown tolerance: If Your investor redeems, game over. he said he would tolerate -5% max drawdown. So, in order to be safe, you should probably calibrate your risk to a fraction of this. If You calibrate at 100%, he will redeem and this is one time where being right is bad, very bad. Besides, you need to rebound from drawdown, so let’s say somewhere between 50%-66.67%, say 2/3
  2. Avg number of positions: over 1 turnover cycle, what is your average number of positions? let’s say: 50
  3. Loss rate: over 1 turnover cycle, what is your average loss rate. In case You don’t know use 60% as loss rate (Yes, it means you lose more often than win, and it is called prudence)

Equipped with this:

Max risk per trade = Drawdown tolerance / (Loss rate * Avg #positions)

= 5% * 2/3 / [50* 60%]

Max risk per trade = 0.11%

Now, that was the max risk per trade. Let’s move to the min risk per trade. This is a fraction of that: usually 40%. So, your min risk per trade would be around 0.05%

Add trading has a cost: 0.036% blended avg, between DMA and high touch at Credit Suisse for example (as a good friend complained again this morning while we were naked in the gym shower !?!).

Now, You probably start to understand why i mean that those customers are toxic. When You go through a drawdown and you will have rough periods, You will simply not be able to dig yourself out.


Once in early 2013, i was cruising at a hedge fund party nursing some nasty Chardonnay and some dude who just launched was explaining his strategy:

-“fundamentals pairs trading”, he proudly said

-“So, You must be Long Toyota and Short Mazda, right? Mazda has gone up 400% and Toyota 30%. That must be a painful trade? ”, i asked

-”Nah, positions are small anyways, so no it does not hurt”, he confidently replied

-”Well, if they are too small to hurt, do You think they are big enough to contribute?”, i candidly asked

And he did the unthinkable rudest thing someone can do in Japan. He gave me back my business card and walked away

How should I manage a client’s portfolio if he wants a 8-10% return and no negative years worse than -5%, and has a starting amount of $2…