Cognitive Scaffold

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MENTAL MODEL · M13142

Position Sizing

Position Sizing
SystemsHigh supportRisk Management
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Updated 2026-08-17

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INTRODUCTION

English translation pending.

CORE DEFINITION

Position sizing is the decision about how much capital to commit to a single trade, bet, or project. The Kelly criterion, published by John L. Kelly Jr. at Bell Labs in 1956 and later applied to markets by Edward Thorp, gives the growth-optimal fraction from the win probability and the payoff ratio. The Turtle Traders, taught by Richard Dennis and William Eckhardt in the 1980s, instead fixed risk per trade as a small percentage of equity and scaled the position by the instrument's volatility. Sizing is often said to matter more than selection, because no run of small bets recovers from one position large enough to wipe out capital; the correct fraction depends on edge, odds, and correlation.

SCAFFOLDING EFFECT

psychology

Reduce cognitive load

- Risk budget: Fix the maximum loss per bet as a fraction of capital before choosing the bet. - Size formula: Convert edge, odds, and correlation into a fraction, then cut it for estimation error. - Survival check: Simulate a losing streak to confirm the position cannot end your ability to keep playing.

anchor

Anchor fast decisions

Growth compounds multiplicatively, so a single bet large enough to lose most of the capital resets the process regardless of how good the average bet was. The Kelly criterion maximises long-run growth by balancing the gain from a favourable edge against the drag from variance, and it shows that betting more than the optimal fraction lowers growth while raising risk. Because the optimal fraction is computed from estimated parameters, real edges that are smaller than believed call for betting well below the theoretical value.

MINIMUM ACTION

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Source support: Explicit

  • link
    github.comhttps://github.com/kcchien/model-thinkingZH · Explicit
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