Many spread traders are content to use a simple system for position sizing, such as a set percentage (often 2%) of account size at risk on any one trade. Anyone can work out 2%, and by looking at the worst case price move for a loss, see how much should be staked. The problem that some people have with this is that it is slow to accelerate the size of your stake, and your account can take a while to build up.
Now if you are even looking at position sizing, congratulations, as quite a few spread traders seem to deal with this aspect of risk management “by the seat of their pants”. This is more likely when trading in financial markets that have contracts, such as the futures or Forex markets, where the choice may be to take one contract usually or take two if you are feeling lucky. When trading shares, or spread betting, where you have a greater choice on the size of bet, it makes sense to size the trades properly.
Fixed ratio position sizing is an attempt to accelerate the growth of small accounts more quickly, depending on the parameters chosen, and it was put forward by Ryan Jones in 1999 in his book “The Trading Game”. He explains it in terms of the number of contracts.
He uses a variable he calls delta, although it is not connected with the Greek characters used to describe option contracts. This is a key value that defines how aggressive the position sizing is going to be. The system depends only on how much profit you have made and the value of delta, and pays no attention to the amount of risk for a particular trade.
Fixed ratio position sizing demands that you increase the number of contracts you trade every time you increase your account equity by the value of delta, which may be £5000. When you start, you trade one contract as you have no profit, and it does not matter how large your account is, £20,000 or £100,000. This is a criticism that has been levelled at fixed ratio position sizing, and why it works best when used on small accounts, provided sufficient wins are scored.
The system is designed to increase the number of contracts more slowly as you build profit, so you add one contract to trade two contracts when your account has increased by £5,000, but to add another contract to trade a total of three, you then need an increase of £10,000. A total of four contracts would require an additional £15,000 profit. It is this aggressive start to increasing your stake that makes it considered suited to small accounts looking for aggressive growth.
If you are to use this system in other forms of trading such as stocks, you could obviously increase the number of shares using the same pattern. The main problem seems to be that it is great if you are winning most of the time, and increases your account more quickly than other methods, but there is no assessment of risk in deciding how much to trade, which could get you in trouble and hurt your account.