Fixed Fractional Position Sizing

Fixed fractional is the most widely recommended position sizing method for active traders because it naturally compounds gains and limits losses through portfolio growth/shrinkage mechanics.

**The mechanics:** - Choose a fixed fraction f (e.g., 1% or 2% of current portfolio value) - Each trade: Risk = f × current portfolio value - Position size = Risk / (entry price - stop loss price)

**Why it outperforms fixed dollar sizing:** - After 10 wins growing portfolio from $100K to $150K: 1% fixed fraction = $1,500 per trade risk (compounds) - After 10 losses shrinking portfolio to $80K: risk drops to $800 (self-limiting) - Fixed dollar sizing doesn't adapt — you'd still risk $1,000 at $80K portfolio (1.25% risk instead of 1%)

**The geometric mean:** Fixed fractional sizing maximizes the geometric mean of returns (what your money actually compounds to) rather than the arithmetic mean (what average return implies). Since you're reinvesting from a changing base, the geometric mean is what matters for long-term wealth.

**Relationship to Kelly criterion:** Kelly criterion calculates the theoretically optimal fixed fraction for a given win rate and payoff ratio. Full Kelly is mathematically optimal but practically volatile — most traders use half-Kelly or quarter-Kelly to reduce variance.

**Practical implementation:** 1. Calculate maximum dollar risk for each trade: 1% × current portfolio 2. Determine stop loss distance in % (e.g., 5%) 3. Position size = dollar risk / % stop distance 4. Recalculate after each significant portfolio change