Fixed Fractional Position Sizing 

Introduction to Fixed Fractional Position Sizing

The Fixed Fractional position sizing method, conceived by Ralph Vince, is an essential aspect of the FinStudio Charts module, ensuring that a trader’s risk exposure is kept in proportion to their trading capital. This method directly integrates trade risk management into the sizing of trade positions, maintaining a consistent risk profile relative to account equity.

Conceptual Framework

• Equity Proportionality: The core principle of Fixed Fractional position sizing is to risk a constant fraction or percentage of the account equity on each trade. This approach keeps the risk amount proportionate to the equity level, whether it increases or decreases.
• Risk Definition: The risk on a trade is the monetary amount that a trader stands to lose if the trade were to hit the stop-loss level. This can be based on a predetermined money management stop, the maximum historical drawdown of the trading strategy, or the average loss per trade if no stop-loss is used.

Introduction to the Example

Using the Fixed Fractional position sizing method can dramatically illustrate how consistent risk management coupled with a successful trading strategy can lead to exponential growth of a trading account. Let's delve into a detailed example to see how the Fixed Fractional method works in practice and the potential it has for scaling profits.

Example Breakdown

The table summarizing the progression of account balance using the Fixed Fractional position sizing method has been created. Here's how the account grows with each milestone of 1,000 pips gained, based on the value per pip which increases as the account balance grows:

• Starting Point

  • Initial Capital: A trader begins with an initial capital of $10,000.
  • Risk Management: The trader adopts a Fixed Fractional methodology, deciding to risk 1% of the account equity on each trade.
  • Trading Strategy: The strategy in place aims for an average gain of 10 pips per trade.
  • Trade Size: Initially, the trader chooses to trade with a value of $10 per pip, which corresponds to a prudent risk level for the starting capital.

• First Growth Phase

  • Profits Accumulated: After 100 trades, each yielding an average gain of 10 pips, the trader has accumulated profits of $10,000.
  • Account Growth: With $10 per pip for the trading size, the total account balance becomes $20,000 ($10,000 initial capital + $10,000 profit).

• Scaling Up

  • Trade Size Adjustment: Following the Fixed Fractional method, the trader now increases the trade size in accordance with the doubled account balance, going from trading at $10 per pip to $20 per pip.
  • Further Account Doubling: The subsequent 100 trades, still averaging 10 pips per trade but now at $20 per pip, grow the account to $40,000.

• Continued Progression

  • Proportional Increase: As the trading progresses, the trader continues to adjust the trade size in line with the Fixed Fractional method, always risking 1% per trade based on the current account balance.
  • Geometric Growth Pattern: The account experiences geometric growth, with each set of 1,000 pips gained resulting in a doubling of the account balance. The progression unfolds as follows:
    • $20,000 + 1,000 pips @ $20/pip = $40,000
    • $40,000 + 1,000 pips @ $40/pip = $80,000
    • $80,000 + 1,000 pips @ $80/pip = $160,000
    • Continue this pattern until significant growth milestones are reached.

Compounding Effect and Risk Management

The Fixed Fractional model showcases the power of compounding - each gain increases the account size, which in turn increases the position size for subsequent trades, leading to potentially larger gains. However, it's crucial to note that this model also increases the risk in dollar terms, even though the percentage risk remains the same.