When to Adjust Position Size

Mar 8, 2008: 11:07 AM CST

In my previous post entitled “Gambler’s Fallacy” I mentioned that you should not radically alter your position size (or trading frequency) based on the outcome of the last handful of trades. But when is it appropriate to adjust your position size?

Recall that the Gambler’s Fallacy occurs based on emotions, whether positive or negative. If your last few trades have been winners, and you’re newer to trading, this can lead to a sense of invulnerability, which can lead you to double (or triple) your normal size, and in doing so, you expose yourself to heightened emotional stress, and if the trade turns out to be a loser, you may hold on longer or behave differently, creating a larger than expected loss.

The key to creating the Gambler’s Fallacy is your faulty assumptions based on the most recent outcomes, rather than having a specific plan to change trading frequency or position sizing.

When might it be appropriate to change?

That depends on you and your selected strategy which you have predetermined either through experience or research.

Typically, a trader should change tactics whenever he or she perceives that the broad market, or the trading environment has changed. The market alternates between bull and bear, range and expansion, dull and volatile, fast and slow. You should have predetermined rules for analyzing the quality (or condition) of the market you’re trading so you can make clear distinctions and try to set up a framework of the current conditions and what may be coming next – and thus adjust your strategy.

In a raging bull market, increase your position size to the long (buy) side, because odds favor higher prices and positive resolution of trade set-ups (or stock selection). “A rising tide lifts all boats,” and you also want to “make hay while the sun still shines.” You may either choose to decrease trading activity because you want to hold positions longer, instead of trading in and out of them daily.

During a dull, flat, lifeless consolidation phase, you may want to increase your trading frequency on a reduced position size to take advantage of rangebound market swings (or you may wish to decrease your frequency and take a break from trading during this difficult period).

Also, your particular strategy will likely experience changes in the edge or expectancy during different conditions. As I’ve mentioned previously, the classic “Gap Fade” strategy performed wonderfully in January 2008, but decreased edge in February. Trader Eyal in a recent post also mentioned this phenomenon and described it well (including the shock that accompanies it) in his post “The Anatomy of Re-learning How to Trade.”

It is best to decrease trading size when your strategy shifts out of favor (or experiences reduced edge) in the Market. Educator Bo Yoder refers to this as the “Pay-out, Pay-back” cycle and notes that a major component of long-term success as a trader is knowing when your specific strategy is coming into a ‘pay-out’ cycle where it is aligned with the market (in which you increase trading frequency and/or size) or a ‘pay-back’ cycle, where your strategy has fallen temporarily out of favor, and you should decrease size and frequency or maybe take a break until you are sure (or assume) that your strategy has once again come back into favor.

Nevertheless, professional traders do increase or decrease both position size and trading frequency, but they do so based on a specific set of rules or variables that they identify, and they do so based on rules, rather than emotions. They certainly do not stress because their last handful of trades have been losers, or double-up because they have experienced a few wins.

Professionals deliberately adjust based on factors far beyond their emotions, while newer traders adjust almost exclusively based on their emotions. This is one of the key differences between creating the Gambler’s Fallacy or trading in line with market analysis according to a predetermined plan.

(Thanks to Tyro Trader for the inspiration for this post)


8 Responses to “When to Adjust Position Size”

  1. Tyro Says:

    Thank you for this. I think the key paragraph is at the very bottom. New traders may try to emulate pros, but they get messed up in the execution.

    Can I just add a little perspective from a journeyman trader? I know enough to know that my thinking isn’t always clear, but I don’t yet know enough how to clear it.

    Here’s what I often go through, sorting out my (largely intuitive) evaluation of the market from my hopes, fears, and wishes. Take the question of increasing size. After a string of winners, I’m tempted to increase my size, thinking I’m on a roll. I’m aware of that bias, so I tell myself I should stick with the same size. But once I recognize the impulse to increase size, I wonder if I may be getting overconfident and so think I should decrease size. Then I can’t help but wonder, maybe these wins are because the market has shifted in my favour and I need to take advantage of this by increasing size. Then I think the markets don’t shift very quickly so I should be cautious, but I think back to last February or some of the extremes of emotion we’ve seen and I know that the market does change fast sometimes and these can be moments of great opportunity if you act quickly. But then I think I’m making this too complicated, and trying to find excuses to increase my size which makes me wonder if I’m getting overconfident, and the dizzying mental exercise starts all over 🙂

    Whatever it is, I think we can think of the really bad cases, where people take a string of losses and then go from 100 shares to 20,000 in order to make up all their losses, figuring they’re “due” for a change, or people who take five decent winners, increase size and then blow all their losses in one trade. That’s probably a lot more common and damaging than my version of navel-gazing!

    Some of this comes with experience, but then overconfidence also comes with experience… I gotta say that your blog, which takes a calm and reasoned approach does help newbies like me, by providing some balance. Great stuff as always.

  2. Corey Rosenbloom Says:


    It happens! I’ve been there, and as I am becoming more professional, I get overconfident easier and take on larger positions because I think I finally have everything figured out. I don’t, and losses let me know that! Trading is a numbers game, and one of edges and probability, and our task is to identify our edge and let the trades (numbers) add up over time, and not create a scenario where a handful of trades can swing our account greatly up or greatly down. My goal is a steadily increasing equity curve.

    What you describe is so common to traders. It is a cycle that sets up which wrecks havoc on your emotions and – often – your account. I know of more than a few traders who did that (vastly increase position size) after a big loss or a string of losses. Some of those people unfortunately no longer trade, but a handful used that experience as a major (expensive) learning lesson that opened their eyes to the difficulties of trading, and that a more stable approach was needed.

    Thank you so much for the compliments – I do try to pull the perspective back and attempt to slow the action down for readers and highlight key educational opportunities, or speak calmly during volatile times (even if my own psychology is getting quite anxious!). My experience teaches that it’s better to achieve goals in trading slowly, rather than rapidly.

    It’s such an exciting activity (trading) and is full of so many rewards, but inherently, it’s far more difficult than it seems on the surface. But – as long as we keep our losses small and not endanger our account significantly – this is such a fun game that keeps us coming back!

  3. eyal Says:

    Hey Corey, thanks for the mention. I agree that reducing size is a good first step. The first priority of a trader is to survive, both in capital and mentally. Keeping size large (or worse, increasing it) when your strategy is experiencing a prolonged drawdown or you’re out of tune with the market is a recipe for disaster. On the other hand one shouldn’t change size too often without good evidence of something going wrong and at the same time be ready to increase size back fast if conditions change positively again. As you say, it’s difficult to get it right all (or even most) of the time, but nothing in trading is easy 🙂

  4. MWF Says:

    excellent post!

    “After a string of winners, I’m tempted to increase my size, thinking I’m on a roll. I’m aware of that bias, so I tell myself I should stick with the same size. But once I recognize the impulse to increase size, I wonder if I may be getting overconfident and so think I should decrease size.”

    hmmm…very interesting comment tyro

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