Position Sizing according to Van K. Tharp

[bryanmcn]

Dr. Van K. Tharp has written several best selling books about trading. He has been profiled in "Market Wizards". He recommends position sizing and setting stop limits that limit risk according to the volitility of the stock.
For example; Lets say you have a total portfolio of $100,000 all in cash and want to start trading. You are looking at ICS. How much should you buy and where should you place your stop loss?
 - Presently ICS closed at $.87.
 - It has a weekly trading range of about $.10 per share or about 12% (its volatility).
 - Tharp recommends limiting your risk in any one position to no more than about 2% of your total portfolio so you don't want to lose more than about $2000 on this trade. 
 - $2000 / .12 = $16,666 - say $17,000.
So buy about 20,000 shares and set your stop at .77 increasing it if the stock rises.
This limits your risk to $2000 or 2%of your total portfolio.
Comments?

[AnthonyRPF]

Hey bryanmcn,

It seems like a good idea to limit the extremely volatile positions relative to how much you are willing to lose, but the only thing that sticks out to me is setting the stop at the weekly trading range.  I would worry about being unnecessarily stopped out of the position on a volatile week. 

Maybe tweaking the formula slightly would get around the problem of being stopped out too soon.  Perhaps using the weekly volatility ($0.10 for ICS) for the calculations, then setting the actual stop limit at a lower price (perhaps $0.75), would ensure that a decrease in  price which causes the position to be stoped out is a sign of a real downturn and not just volatility. You would lose slightly more than the 2% if it was triggered in this example, but ideally it would keep you in the position despite a highly volatile day/week.  Just a thought...

[Victor]

Hi Bryanmcn,

Considering the volatility here I'd restrict it to 1% until the account is larger, and then use 1/2%.  Van Tharp uses these figures as well.  As AnthonyRPF says, it really depends on the stop selection.  I found 19% to be reasonable for the base system.  However the site no longer recommends the basic system (only the delayed ones).  I could not find a straight % number that was effective for these systems.  You'd have to do some rigourous work with stops to find an effective tool.  Then I'd apply the 1% rule.

As described elsewhere... I've used each system as a separate trade, with a common stop.  Whether one uses a 1% MM allocation for each or for all... it's up to you.  Just remember they are all correlated 100%!

Cheers,

Victor