The Definitive Guide to Position Sizing Strategies

by Van K. Tharp

Quick Summary

Van Tharp's guide to position sizing addresses the most overlooked yet critical component of trading system design: how much to risk on each trade. The excerpts cover judgmental biases that prevent traders from implementing proper position sizing (lotto bias, need to be right, authority bias, law of small numbers) and provide a comprehensive survey of position sizing software tools. Tharp argues that position sizing, not entry signals, is the primary determinant of whether a trading system meets its objectives.

Detailed Summary

This publication represents excerpted material from Van Tharp's "Definitive Guide to Position Sizing Strategies," specifically two sections that were removed from the second edition but retained as bonus material due to their enduring value.

Part I, "Are You Doomed to Failure?", examines the psychological biases that cause traders to ignore or misapply position sizing principles despite their importance. Tharp opens with George Anderla's observation about exponential information growth: the amount of information available to humans doubled between Jesus and Leonardo Da Vinci (1,500 years), doubled again by 1750, again by 1900, and by the 2000s was doubling in less than a year. Since conscious processing is limited to roughly 7 (plus or minus 2) chunks of information, humans rely on judgmental shortcuts -- heuristics that create systematic biases.

Bias 1 is the "Lotto Bias" (external locus of control), where traders believe success depends on finding the right system rather than on managing themselves. Bias 2 is the "Need to Be Right," which causes traders to focus on win rate rather than expectancy (the mathematical edge per dollar risked). Bias 3 involves fixating on percent gain rather than R-multiples (profit as a multiple of initial risk). Bias 4 is the false confidence from multiple confirming inputs that actually contain the same information. Bias 5 is authority bias. Bias 6 is the illusion that prediction and understanding are necessary for profitable trading. Bias 7 is the desire for lots of facts (complexity preference). Bias 8 is the law of small numbers (drawing conclusions from insufficient data). Bias 9 is conservatism bias (difficulty updating beliefs). Bias 10 is representativeness (judging probability by similarity rather than base rates).

Part II surveys position sizing software available in the market, organized into categories: trade tracking software, simulation software, dedicated position sizing software, system-specific software with position sizing capabilities, multi-purpose software with position sizing features, and high-end professional software. Tharp evaluates each category's strengths and limitations for implementing the position sizing strategies described in the main text.

The material emphasizes Tharp's core teaching: most traders spend 90% of their time on entries (which matter least) and 10% on position sizing (which matters most). Position sizing is the one component of a trading system that most directly determines whether the trader achieves their financial objectives.