Can Increasing Position Size After a Win Lead to Greater Trading Success?

Picture this: you’ve just had a winning trade and feel confident.

Should you increase your position size after each winning trade to capitalize on your hot streak? And, after a losing trade, should you expect your bad luck to continue and reduce your position size to minimize potential losses?

These are questions that every trader grapples with, and finding the right balance is crucial to managing risk and maximizing profits.

In this article, I will explore the pros and cons of adjusting position size based on trade outcomes and share insights from successful traders who have mastered this strategy.

Understanding Position Sizing and Its Impact on Trading Outcomes

Position sizing refers to the number of units you invest in a trade, typically measured in lots, shares, or contracts. Position sizing is critical to risk management, as it determines each trade’s potential profit or loss.

We all know that trading a position too large for your account is risky because a losing streak can put your capital at risk and take you out of the game. Large drawdowns are difficult and time-consuming to recover from. You must generate a higher percentage return on your remaining capital compared to the percentage loss of your drawdown.

Trading a size too small is less risky, but you will have an opportunity cost from spending time and effort trading.

In this article, I will focus on adjusting your position size dynamically based on your recent trading success.

By adjusting position size based on the size of your account and expected trade outcomes, you can optimize your risk-reward ratio and improve your overall performance.

Increasing Position Size - adjust your trading position size depending on the expected outcome

Adjust Your Position Size To The Size Of Your Trading Account

Firstly, it is crucial to trade a position size that is appropriate to your trading account.

There are many different factors and ways to deal with this, but a good rule of thumb is never to risk more than a small percentage of your account on each trade.

If you are trading your own money, you probably want to take on less risk than you think to minimize your risk of blowing up.

Adjust Your Position Size Based on Winning and Losing Trades

The question of whether to dynamically adjust your position size is based on optimizing your return.

I will focus on two key choices: you have just had a winning trade – what do you do for the next trade?

  1. Keep your position size the same – assuming no reliable winning or losing streaks exist.
  2. Increase your position size on a winning trade – assume there are winning or losing streaks.

So What is Best?

It depends on your strategy and the profile of your winning and losing trades.

If you trade a high win rate strategy with many small winning trades and a few large losing trades, consider increasing your position size following a winning trade.

If you trade a relatively even or low win rate strategy, you should trade an even position size.

Why You Should Increase Your Position Size After a Winning Trade (If You Have a High Win Rate Strategy)

There are two reasons for this.

Reason 1: Markets Tend to Trend

We know that financial markets are prone to streaks and fat tails.

On a minute-by-minute basis, the markets are essentially random. But over time, market themes and narratives drive non-random clustering of trading results.

These streaks are referred to as a skewed distribution. This skewed distribution allows you to increase your overall returns.

Reason 2: Basic Mathematics

Even though financial market returns are skewed, there is still a lot of randomness. This randomness comes from all sorts of factors. Large numbers of buyers and sellers react differently to information. Large institutions, hedge funds, market makers and retail traders have different risk tolerance, timeframes and intentions.

We can use this randomness to help us understand what will happen based on a trading strategy’s expected win rate percentage.
Let’s go through some potential scenarios.

Let’s go through some potential scenarios.

50% Winning Trades

If you have a strategy that delivers roughly 50% winning trades, you may not have many big winning streaks, even in a trending market, because of randomness.

In a purely random market you will get a losing trade 50% of the time following a winning trade. Imagine that each time you increase your position size and then immediately have a losing trade you will be faced with a loss roughly equivalent to the size of your first win.

Example – One Winning Trade Followed By a Losing Trade: Assuming you gained $100 profit in your first trade, you will lose $200 in your second trade, leaving you -$100 for your two trades.

60% Winning Trades

If you have a strategy of 60% winning trades, you will get slightly more and slightly longer winning streaks.

Every time you have a winning trade, you have a 60% chance of at least one more winning trade.

Example – two Winning Trades Followed By a Losing Trade: Assuming you gained $100 profit in your first trade, $200 profit in your second trade, you would see a $300 loss in your third trade. Leaving you at breakeven after your three trades.

70% Winning Trades

This is where it starts to get interesting. The odds begin to shift dramatically.

If you have a strategy of 70% winning trades, you will get even more winning streaks and longer winning streaks.

Now you have a 70% chance of at least one more winning trade. And you will start to see a decent chance of a very long winning streak You now have a roughly 1% chance of a streak of 9 wins in a row. This is where you make the outsized returns which could make you profits for your whole trading year.

Managing Risk With Dynamic Position Sizing

If you are increasing your position size following a winning trade, you will be increasing risk. To offset this risk, you need to start with a smaller position size than if you use fixed-position sizing.

Quick Summary – The Upside of Increasing Position Size After a Winning Trade

  1. Increased profits: By increasing your position size after a winning trade, you can potentially capitalize on your momentum and generate higher returns on the following trades.
  2. Improved confidence: A winning streak can boost your confidence, which may lead to better decision-making and a more positive trading mindset.

Quick Summary – The Downside of Increasing Position Size After a Winning Trade

  1. Increased risk of losing gains: While larger position sizes can lead to higher profits, they also come with increased risk. You give back your previous gains if your next trade is a loser.
  2. Overconfidence leading to poor decision-making: A string of winning trades can lead to overconfidence, which may cause you to overlook important market signals, leading to poor decision-making and potential losses.

How To Manage Dynamic Position Sizing With an Algo Trading Strategy

Dynamic position sizing is much easier to manage with an algorithmic trading strategy. You set your rules, and the algo follows them without errors and emotion.

The Unity Excel Trading Model is a tool that empowers traders to analyze historical market data and optimize their position sizing based on the outcomes. By leveraging this model, you can enhance your risk management and achieve optimized returns while effectively navigating the complexities of the market. The Unity Trading Model provides a comprehensive framework to fine-tune your position sizes and align them with your risk appetite and overall trading objectives.

Key Takeaways and Recommendations

In conclusion, adjusting position size based on trade outcomes can be a powerful risk management strategy. However, it’s essential to strike the right balance to avoid overconfidence or overly conservative trading. Here are some recommendations for effective position sizing and risk management:

  1. Track your win percentage: Make this high win rate a key part of your trading strategy. Mean reversion strategies have a higher win rate than trend following. Choose multiple exit strategies to exit trades for a profit.
  2. Establish a clear risk management plan: Determine your risk tolerance and set a maximum percentage of your trading capital you’re willing to risk on each trade.
  3. Monitor your performance: Regularly review your trading performance with and without dynamic position sizing to identify patterns and adjust your position sizing strategy accordingly.
  4. Stay disciplined: Stick to your plan and avoid making impulsive decisions based on emotions. No revenge trading!

By mastering the art of position sizing and implementing effective risk management strategies, you can improve your overall performance and achieve long-term success in the markets. Carefully considering your strategy and adjusting position size based on trade outcomes, you can unlock the full potential of your strategies.