New Techniques  |  MAY 2009

True Range, Reward/Risk, And Position Size by Alan M. Binder

True Range, Reward/Risk, And Position Size by Alan M. Binder This method uses the concept of value at risk and true range to determine a reward to risk ratio and position size for trading stocks. The process has been reduced to two Excel spreadsheets for ease of calculation. Reward/risk ratio and position size are two variables you need to know before you initiate a trade. Value at risk (Var) will help you calculate these two variables. The Var of an equity position is the amount of money that you can expect to lose during a fixed period within a certain probability. Using the usual measure of mean and standard deviation of percentage price changes as a measure of risk, you can measure the underlying stock risk to determine if it falls within acceptable limits based on your account size and the amount you are willing to lose on the trade. Position size tells you how many units, or shares, you are going to put on, given the size of your account. Position-sizing is the essence of money management. Too few shares or units and your return will be inadequate. Too many and your risk will be too high. By using a security’s volatility or true range (TR) to evaluate Var, you can determine the appropriate position size based on your risk tolerance and the typical price movement of the security over a specific period of time.

by Alan M. Binder