position-sizing-a-la-michael-platt

A Model for Maximum Asymmetry

Michael Platt's approach to position sizing is as disciplined and as data-driven as his approach to risk management. He understands that position sizing is one of the most important decisions a trader can make. It is the one variable that you have complete control over, and it can have a massive impact on your long-term results. A good position sizing strategy can amplify your winners and minimize your losers. A bad one can do the opposite.

Platt's position sizing model is based on the concept of the "Kelly criterion." The Kelly criterion is a mathematical formula that is used to determine the optimal size of a series of bets. In the context of trading, it can be used to determine the optimal size of a position, based on the probability of success and the expected return. The formula is as follows:

Kelly % = W – [(1 – W) / R]

Where:

• W = Winning probability
• R = Win/loss ratio

A Practical Example

Let's say you have a trading strategy that has a 60% win rate and a win/loss ratio of 2:1. This means that for every dollar you risk, you can expect to make two dollars. Using the Kelly criterion, you can calculate the optimal position size as follows:

Kelly % = 0.60 – [(1 – 0.60) / 2] = 0.40

This means that you should risk 40% of your capital on each trade. This may seem like a high number, but it is the mathematically optimal position size. Of course, the Kelly criterion is just a theoretical model. In the real world, you would probably want to use a more conservative position size, such as half Kelly or quarter Kelly. The point is that you should have a systematic approach to position sizing. You should not be guessing.

The Michael Platt Twist

What makes Platt's approach to position sizing unique is his use of a dynamic model. He does not use a fixed position size. He adjusts his position size based on the volatility of the market and the performance of his traders. When the market is volatile, he reduces his position size. When the market is quiet, he increases it. When a trader is performing well, he gives them more capital to work with. When a trader is underperforming, he takes capital away. This dynamic approach to position sizing is one of the keys to BlueCrest's success.