You probably know the saying about giving a man a fish…he’ll eat for a day.
But teach him how to fish, and he’ll feed himself for a lifetime.
Quant Trader operates on the same principle. The service isn’t just about identifying stock opportunities. No, it’s about so much more…
My aim is twofold:
- Identify profitable trades for you, and
- Develop your trading skills
People naturally think about the first goal. But the second is just as important.
You see, knowledge underpins success. I want you to be able to replicate Quant Trader’s strategies for yourself. And the best way I can help you do that is to upscale your skills.
Last week’s update was about trade sizing. You saw the first of two strategies for deciding ‘how much’ to buy. This is one of the most important decisions a trader can make.
I’ll explain the second strategy in a moment. You’ll see how many professionals determine their trade size. This could give you a big advantage over most retail traders.
But first, here’s a recap of last week…
One size fits all
Strategy 1 is the ‘fixed trade size’ approach.
The beauty of this method is its simplicity. There are no complex calculations. All it requires is for you to decide on a set amount for every trade. Your account size will be a key input.
An advantage of fixing your trade size is that it spreads your risk evenly. This ensures you don’t have too little capital in your best trades, or too much in your worst.
Here’s the chart you saw last week:
This is how the fixed method performs over a 24-year period.
The back-test turns a hypothetical $100,000 into over $469,000. And it does this by placing an even amount on each trade — in this case, $1,000. There’s no allowance for costs or dividends.
The system uses the same entry and exit rules as Quant Trader. The only difference is that it only trades signal 1s. The portfolio also has a cap of 100 stocks.
You’ll notice the account rises in a broad upward trend. There are many pullbacks along the way. But these are mostly due to market corrections — not a calamity in a single large holding.
The 370% gain also outpaces the All Ordinaries.
And remember, this is all from using a consistent trade size.
This leads to a key question: As your profits grow, how and when could you increase trade size?
OK, let me show you another way to set your position size. This how many of the pros trade. It’s also the strategy I use myself.
The previous approach uses a fixed dollar amount.
This next method has one important difference: it uses a fixed percentage of capital.
Let me explain the difference…
Suppose you have $100,000. Under the fixed dollar method, you might invest $1,000 per trade. This figure remains constant into the future. There’s no mechanism to increase the value.
Now, say you allocate 1% of capital to each trade. Your initial trade size would still be $1,000.
But here’s the key point: As your capital changes, so does the trade size — it dynamically adjusts.
Here’s an example:
Imagine your portfolio’s value increases by 10% to $110,000. Your trade size automatically rises to $1,100 — that’s 1% of $110,000. The opposite happens if your capital shrinks.
This process continues indefinitely. It ensures your capital and trade size are always in proportion.
Have a look at this chart:
This is the hypothetical result of using the percentage method. It covers the same 24-year period as the previous test. As before, there’s no allowance for cost or dividends.
The charts for the two approaches look similar at first glance. And so they should — the entry and exit strategies are identical. The only difference is the position sizing algorithm.
But have a close look at the slope of the two curves. You’ll notice the percentage of capital strategy rises at a steeper angle. And this has a dramatic impact on profitability.
Let me show you what I mean:
How about that for a difference?
One of the strategies (the blue line) adapts to changes in capital. The other strategy doesn’t.
You’ll notice that the divergence doesn’t happen immediately. It takes about six years to become noticeable. This is because the initial adjustments in trade size are only small.
But look at what happens over time.
This is the magic of compounding — your profits go on to generate more profits. You don’t get this powerful tailwind with a static trade size.
Of course, you need to be aware that the dollar value of your losses also increases. But they remain in proportion to your capital. That’s the benefit of dealing in percentages.
Don’t worry if you’re not ready to use the percentage method. There’s nothing wrong with fixing your trade size. This is just something for you to consider.
Also note that the back-testing starts with 1% of $100,000, or $1,000. This won’t work if your capital base is $20,000. Your trade size would be an unworkable $200.
If you do have a smaller account (for example $20,000), you could use 5% of capital per trade. This would initially give you 20 trades of $1,000. You can always make adjustments over time.
Position sizing is more science than art. It took me years of trial and error to figure this out. You now have the formula. I hope this helps you transform your trading.
Until next week,
Editor, Quant Trader
Editor’s note: Anyone can follow a stock tip. But fewer people can trade the market on their own.
Aside from identifying moneymaking stocks, Jason’s aim is to develop your trading skills. He wants you to become a confident and profitable trader in your own right.
All graphics produced by Quant Trader unless otherwise noted.