‘Diamond-shaped’ position sizing strategy for currency trading
Adding to a winning trade: using a diamond-shaped approach to increase position size
Yesterday, I published ‘Adding to a winning trade: forex position sizing and risk profile‘ where I illustrated in tables 3 models for increasing position size:
- Inverted triangle or inverted pyramid with high average entry price
- Rectangle with average entry exactly in the middle
- Regular triangle or pyramid with low average entry price
Right after, I got a tweet asking me if we can use a diamond-shaped approach to add position to a winner. Before I go further, let me elaborate a little more about the 3 previous models.
3 models for forex position sizing
The models were meant to investigate how risk measured by average entry price will look like when we add to a winning trade in different position sizes. All 3 models started with the same entry size at a simulated price of 1.3000 EURUSD. The position was upsized each time there was a 1 percent rally in price over the previous entry. Model A which featured an inverted triangle increased position size added by doubling. The outcome was what I dubbed high CG. The average entry price of the overall position was so high that a relatively low correction will bring the position into red.
Based on the 3 models, I concluded that without considering a trailing stop loss, Model C (regular triangle, low average entry price) could tolerate the highest level of correction.
Model D: The diamond-shaped approach to position sizing
This is a follow up of the 3 models that we discussed. Naturally the diamond-shaped approach would look like a Model A- Model C hybrid combining narrow base, fat waist and narrow top. So I basically combined the position sizing for Model A to Model C but to do so I simulated a price rally that went into the 6th round.
Results concur with the hybrid nature of the approach but caution required
The most striking result is that this model has an average entry price in the middle and 1:1 reward to risk ratio making it look just like *SURPRISE* Model B (rectangle shaped, ‘same upsize each time approach’). Given the symmetry of the approach used here, it really is not so surprising. At a glance traders might conclude that this method is superior compared to the other 3. After all, profits look great. In addition, it appears reasonably tolerant to correction up to nearly 3 percent before becoming red. Bear in mind however that model requires a extended rally so that the bulk of the position size added at steps 3-5 needs to become deep in the money.