Definitive Guide to Position Sizing Strategies, 2nd Ed.

By Dr. Van K. Tharp

Self-Evaluation

All of the answers to these questions are contained in the book. We recommend that you complete this
questionnaire as an open book test before you start developing position sizing strategies for your systems.

Chapter 1
1) What are the 10 Golden Rules of Trading?

Chapter 2
2) You buy 400 shares of XYZ for $7,728. You plan to sell the stock if it drops $2.20 from your entry point.
What is your total 1R risk in this position?

3) You buy a stock at $48 with a 25% trailing stop. The stock goes as high as $62 and then drops 25% where
you get out. What is your profit (or loss) expressed as an R-multiple?

4) Let’s say your trading system says to buy corn at $2.10 with an initial stop at $2.05. How many futures
contracts could you buy if you are trading a $30,000 account and you are willing to risk .25% of your equity per
trade? (Remember - there are 5,000 bushels in a corn contract.)

5) Now let’s say corn prices increase significantly during the year and go up to $6.80 per bushel. Given your
answer to #4 above, what would happen to your account? How would you feel after such a move? What would
that reaction mean?

6) Using the entry price and initial stop price above in #4, what would be the R-multiple return for a position in
corn if you were long and the position did go to $6.80 per bushel? Express your answer as an R-multiple of your
initial risk.

Chapter 3
7) What are the variables that allow you to determine your System Quality Number?

8) Figure 18A below shows your last ten trades. Determine your R-multiples (to two decimal places), your
expectancy, and your SQN based on the last ten trades. (Also reference: Chapter 2)
 Figure 18A: Determining R-multiples from Total Risk
Total Profit or (Loss) R-
Transaction
Risk Includes Costs Multiple
400 CSCO at $31 $800 $3,322
80 IBM at $80 $750 −$813
300 VLO at $50 $1,000 $5,413
400 HRB at $48 $800 −$1,531
500 IRF at $58 $700 $3,890
400 ISIL at $18 $600 −$976
600 LSI at $5.38 $750 $4,961
500 MYL at $17.50 $500 −$367
400 ORI at $31 $800 −$2,314
300 SRA at $40.77 $600 1571
Total
Average

9) If this system instead had 100 trades and generated the same expectancy and standard deviation, what System
Quality Number score would it earn, and how would you rate the system?

10) In Figure 18B below, you just have a series of trade results. Calculate the R-multiple for each trade. What’s
your best estimate of the expectancy of the system and your System Quality Number?

Figure 18B: Determining Expectancy without

Knowing the Initial Risk of Each Trade
Profit / Loss
Transaction R Multiple
Includes Costs
400 HRB at $51 −$565
80 IBM at $80 −$499
400 ISIL at $16 $9,782
500 MYL at $17.50 $1,244
400 ORI at $31 −$1,345
300 HD at $46 −$344
50 GOOG at $245 $2,389
2000 FORD at $13.22 $4,500
300 CREE at $25 −$1,240
300 GM at $29 −$1,300
Total
Average

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11) What is the System Quality Number of the trades in Figure 2B? Calculate and list the R-multiple for each
trade. Also show the expectancy for the trades. (See Chapter 2, page 18)

12) Figure 18C below gives you the R-multiple distribution of four systems. Which is the best system and why?
If all four systems generated 100 trades per year, how would they compare to the systems in Figure 3-J?

The summary data on the systems are included at the end, where EXP = expectancy, SD = standard deviation of
R and the bottom line is trades generated per month by the system. Rank the ten systems, including Systems 3-1
through 3-6 and Systems 18-1 through 18-4.

Also indicate, based upon your understanding of System Quality Numbers, if you would trade any of them.
Why would you or why wouldn’t you?

Figure 18C: Systems to Evaluate

System 18-1 System 18-2 System 18-3 System 18-4
3 (−3R) 25 (−1R) 35 (−1R) 5 (−1R)
4 (−2R) 15 (−2R) 12 (−2R) 4 (−2R)
15 (−1R) 3 (−5R) 1 (−5R) 3 (−3R)
15 (1R) 3 (2R) 13 (1R) 2 (−4R)
5 (2R) 5 (4R) 10 (3R) 1 (−5R)
2 (5R) 2 (6R) 4 (9R) 50 (1R)
1 (10R) 1 (10R) 2 (18R)
1 (15R) 1 (20R) 2 (36R)
1 (30R)
1 (50R)

EXP = 0.61 EXP = 1.37 EXP = 1.56 EXP = 0.23

SD = 3.19 SD = 8.61 SD = 6.91 SD = 1.54
20 trades/mo 30 trades/mo 16 trades/mo 28 trades/mo

13) What are the primary factors that influence the System Quality Number? What would you have to do to
your system to get a high SQN? What is the value of having a strong System Quality Number?

14) What is the potential impact of a price shock on your trading?

Chapter 4
15) What are the six questions you should ask yourself about your system?

16) What is a reliable system? What information would you need to know to believe that your R-multiple
distribution is reliable? (Also reference: Chapter 3)

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17) You’ve backtested your trading system and have a year’s worth of trades to show for it (i.e., 50 trades).
What are some common sense questions you should ask yourself to determine if your system is reliable?

18) How would you know if your system is valid?

19) How can you determine what to expect from your system in all kinds of markets? How would you define
the various kinds of markets?

20) What kind of performance measurements should you get from your system before you trade it?

21) Once you have this information, how will it cause you to think differently?

Chapter 5
22) Define a low-risk idea.

23) When you have a 50% drawdown, how much do you have to recover to get back to breakeven? When you
have a 25% drawdown, how much do you have to recover? What does this tell you that’s very important?

24) Define position sizing strategy. What is the purpose of a position sizing strategy?

25) What are the top four biases against using position sizing correctly? What is an example of a position sizing
strategy that you should not use because it focuses on wanting to be right?

Chapter 6
26) What are the three different methods for determining your equity? When might you want to use each of
them?

27) When using a market’s money position sizing model, what equity model should you use? What advantage
does this particular model have? (Also reference: Chapter 11)

Chapter 7
28) Why is the “units per fixed amount of money” model weak?

29) In his newsletter, Louis Navellier requests that his subscribers be fully invested at all times and diversified
equally among each of the stocks he recommends. Quite often, he recommends that you sell some of your
shares of certain stocks and buy more shares of others, always attempting to be equally diversified among each
of his stock picks. What position sizing model is he using? What are the advantages and disadvantages of this
model? Which of the Golden Rules of Trading does the rebalancing technique violate?

30) You are day trading a $50 stock with a 40-cent stop. You only want to risk 0.6% of your $30,000 portfolio.
How many shares can you buy? What is the problem with this sort of position sizing? What is an alternative
form of position sizing that would solve this problem?

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31) You are day trading a $62 stock with a 40-cent stop. The daily volatility of the stock is $2.30. What model
should you use for position sizing? How many shares can you buy, risking 2% of a $50,000 portfolio?

Chapter 8
32) What is group risk? What is portfolio heat? Why are they important?

33) Using the recommended guidelines, calculate the maximum portfolio heat for the following systems-

SQN100 Max
System Title
Score Portfolio Heat
Forex Swing System 3.8
Day Trading System A 5.1
Day Trading System B 2.7
Weather Cycle System 1.1
Reversion System 2.5
Futures Trend System 4.2
Gold/Silver Long/Short System 1.4

34) What tactic might you use that would allow you to safely increase your portfolio heat without undue risk?
(Hint: It involves another position sizing model. Also reference: Chapter 13)

35) What is equity crossover position sizing? When might you use it?

36) What is the primary difference between asset allocation and position sizing?

37) How could you use position sizing if you had to be invested 95% long at all times and your primary
objective was to outperform the S&P 500?

38) You don’t know how much money you’re trading because you’re trading your firm’s money. You know
that if you lose $5 million, you’ll lose your job, but your bonus depends upon how much you make. What
would your objectives be? How could you best position size? What would you base it on and what models
would you use?

Chapter 9
39) When you compare the impact of the various models in Chapter 9, what is your major conclusion?

Chapter 10
40) Name five ways you could phrase your objectives. How many possible objectives could you have?

41) Why do position sizing strategies need to vary depending upon your objectives?

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42) What are some of the drawbacks you would experience using position sizing techniques that go for the
biggest average returns? (Also reference: Chapter 11)

43) Let’s say you have five systems, each with an expectancy of +0.45. Each system also generates 30 trades
per month, giving you an average monthly gain of +13.5R. How might these systems vary? Is it possible that
one of these systems could be terrible while another might be super? (Also reference: Chapter 3)

44) What are some of the assumptions you make when you use a simulator?

Chapter 11
45) Name five ways you could vary a market’s money position sizing algorithm in terms of making the
market’s money your money. What are the advantages and disadvantages of these models?

46) Name four different scaling-in techniques. What are the advantages and disadvantages of these models?

47) Scaling-in position sizing models should usually be combined with a ____________ equity model,
especially if you want a fairly smooth equity curve. (Also reference: Chapter 13)

48) Which is better: a two-tier position sizing strategy or a market’s money position sizing strategy? Give your
reasons for your answer.

Chapter 12
49) What are the five dangers of fixed ratio position sizing?

50) Name 5 key assumptions that could help make fixed ratio position sizing a reasonable position sizing
model.

51) You are using fixed ratio position sizing. Your delta factor is $5,000 and your increment factor is 2 units. If
your risk is $1,000 per unit and you are currently trading four units, how much would your account have to
increase to start trading six units?

52) Once you got to six units, if you had a dampening factor of 50%, how much would your account need to go
down in order to move back to four units?

Chapter 13
53) You want to limit your potential drawdown in your system to 20%. What are three ways (position sizing
strategies) you could accomplish this objective?

54) What Martingale position sizing strategy actually works? Why?

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Chapter 14
55) What is the problem with increasing your position sizing when you are really confident about a particular
trade?

56) Some people advocate selling half of your position when you can raise your stop enough to break even on
the trade. What is the problem with this approach and what psychological bias does it reflect?
57) What is the term that encompasses many of the position sizing strategies that you should avoid?

58) What are the four biggest problems with using the percent risked based on the win rate (Model 31)?

59) What are the assumptions of the Kelly Criterion and why doesn’t it apply to position sizing?

60) What are the major problems with using optimal f to determine your position sizing?

Chapter 15
61) What did you learn from the interview with Chris Anderson? How does he exemplify what we’ve discussed
in this book?

Chapter 17
62) What the do you need to take before you can determine what position sizing strategy to employ?

You may request an answer key for this test via email from -

[email protected]

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