You have $10,000 and found 3 amazing traders:
- Trader A: Sharpe 1.5, MDD -20%
- Trader B: Sharpe 1.4, MDD -22%
- Trader C: Sharpe 1.3, MDD -25%
You can't copy all three equally. The collective drawdown might exceed your tolerance.
So you need to size your positions differently.
The Position Sizing Problem
Why Sizing Matters
Problem: If you copy all three traders equally ($3,333 each), your portfolio's worst-case drawdown could be -22-25% (if they all drop simultaneously).
Solution: Size them based on their individual risk (MDD).
- Traders with lower MDD get larger allocation
- Traders with higher MDD get smaller allocation
Result: Portfolio-level drawdown is controlled.
Position Sizing Formulas
Formula #1: Risk Parity Sizing
Concept: Allocate inversely to risk (MDD).
Trader Risk Score = |Maximum Drawdown|
Total Risk = Sum of all trader MDD
Each Trader Allocation = (Trader Risk Score / Total Risk) × Total Capital
Example:
Trader A: MDD -20%, Risk = 20
Trader B: MDD -22%, Risk = 22
Trader C: MDD -25%, Risk = 25
Total Risk = 67
Trader A Allocation = (20/67) × $10,000 = $2,985
Trader B Allocation = (22/67) × $10,000 = $3,284
Trader C Allocation = (25/67) × $10,000 = $3,731
Result: Traders with lower risk get more capital, balancing drawdown exposure.
Formula #2: Fixed Allocation (Simple)
Concept: Equal allocation, but respecting drawdown tolerance.
- Only copy traders with MDD better than your tolerance
- Divide capital equally among them
- Profit
Example:
- Your tolerance: -20% max drawdown
- Copy 4 traders with MDD -8%, -12%, -18%, -15%
- Allocate $2,500 each
- Portfolio MDD: ~-18% (worst individual trader)
This works 80% of the time for simple portfolios.
Real Examples of Position Sizing
Example 1: Conservative Portfolio
Your profile:
- Total capital: $5,000
- Risk tolerance: -15% max drawdown
- Goal: Steady growth
Traders you found:
- Trader A: Sharpe 1.8, MDD -8%, 35% annual return
- Trader B: Sharpe 1.5, MDD -12%, 30% annual return
- Trader C: Sharpe 1.2, MDD -15%, 25% annual return
Risk Parity Sizing:
Total Risk = 8 + 12 + 15 = 35
Trader A: (8/35) × $5,000 = $1,143
Trader B: (12/35) × $5,000 = $1,714
Trader C: (15/35) × $5,000 = $2,143
Portfolio expected return ≈ 29% annually
Portfolio worst-case drawdown ≈ -14% (controlled)
Example 2: Aggressive Portfolio
Your profile:
- Total capital: $10,000
- Risk tolerance: -30% max
- Goal: High growth
Traders you found:
- Trader X: Sharpe 1.3, MDD -18%, 40% annual return
- Trader Y: Sharpe 1.2, MDD -25%, 38% annual return
- Trader Z: Sharpe 1.1, MDD -32%, 35% annual return
Risk Parity Sizing:
Total Risk = 18 + 25 + 32 = 75
Trader X: (18/75) × $10,000 = $2,400
Trader Y: (25/75) × $10,000 = $3,333
Trader Z: (32/75) × $10,000 = $4,267
Portfolio expected return ≈ 37% annually
Portfolio worst-case drawdown ≈ -28% (within tolerance)
Common Position Sizing Mistakes
❌ Mistake #1: Equal Allocation Without Risk Adjustment
Wrong: 3 traders, $3,333 each. Trader 1 has MDD -10%, Trader 2 has MDD -45%. Your portfolio worst-case: -45% (uncontrolled)
Right: Trader 1 gets $5,000 (low risk), Trader 2 gets $1,000 (high risk). Portfolio worst-case: -15% (controlled)
❌ Mistake #2: Over-Concentrating in Best Performer
Wrong: Best performer has Sharpe 1.9. You allocate 80% to them. They blow up, your portfolio collapses.
Right: Allocate based on risk, not performance. Diversify even across great traders.
❌ Mistake #3: Not Rebalancing
Wrong: Set allocation once, never rebalance. Allocations drift, risk profile changes.
Right: Rebalance monthly or quarterly. Maintain consistent risk profile.
Key Takeaways
Continue Learning
Maximum Drawdown Explained
Understand the risk you're sizing for
The Trader Evaluation Checklist
Find traders worth sizing properly
