Macrobook

Risk: Position Sizing / Game Simulations / Kelly Criterion

Welcome to another article from the Macro Book. In the third section of our series, I will explore the ideas and intricacies of risk and position sizing in more detail.

As a reminder for all new subscribers, I announced late last year that I will publish a series of articles about PAMB (Paper Alfa Macro Book). This will encompass all relevant elements of a full investment process. We will cover the following important stages.

1. Idea Generation (Article 1, Article 2)

2. Idea Structuring (Article 1, Article 2)

3. Risk / Sizing (Article 1, Article 2)

4. Portfolio Construction

5. Risk Management

This will be fun and educational, aiming at anyone interested in all the necessary aspects to make this actionable. I will also make it interactive and provide useful tools for those interested.

Finally, we will run a portfolio of fictional trades encompassing any available tradeable, liquid asset class. All subscribers will be able to participate in the idea generation. We can even set up a mini-investment committee to steer the portfolio. It will be, therefore, more strategic than a day-trading vehicle.

Source: Dall-E

In the second instalment in the risk section of the macro book, we covered tools and applications for measuring risk. I have sorted it from pretty standard measures, such as ATR (Average True Range) and Standard Deviation, to more complex methods, like CVaR and EVT (Extreme Value Theory).

We will now focus on possibly one of the most important tasks in investing: sizing positions. We will look into intuitive ways of choosing appropriate sizing and I will run through a few game simulations to uncover some of the main aspects and improve our overall understanding. I will then discuss the Kelly Criterion and how this could be applied to investing.

Let’s dive straight into it.