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2006issue C121-5

Leverage caps and concentration limits

A longer-term position can be sized so a maximum loss near 7% to 8% of capital is planned in advance. Using more than about four-to-one leverage is described as taking too much risk, and a large undiversified commitment can destroy a firm when that market turns.

  • A longer-term position can be sized so that a maximum loss near 7% to 8% of capital is planned in advance.
  • Using more than about four-to-one leverage is described as taking too much risk and as a path to going broke.
  • A strategy with favorable odds can still fail if leverage is high enough that one unfavorable episode wipes out the account.
  • A large, undiversified commitment to a single market can destroy a firm when that market turns against the position.
Entries in this reading3 entries
Current trackPosition concentration limit16 readingsDiversification59 readingsLeverage control70 readings

Plan the loss before the trade

A longer-term position can be sized so that a maximum loss near 7% to 8% of capital is planned in advance. The size decision is made against that planned loss, not after the idea already looks attractive.

Excessive leverage is identified as a primary reason traders lose capital. The archive presents that finding as a sizing problem: the position is too large relative to equity before price has a chance to prove the idea.

Leverage as a hard ceiling

Using more than about four-to-one leverage is described as taking too much risk and as a path to going broke. Leverage control is a hard ceiling on borrowed exposure so a single adverse move cannot wipe out equity.

A strategy with favorable odds can still fail if leverage is high enough that one unfavorable episode wipes out the account. The ceiling is applied before entry and kept in force for as long as the position is open.

Concentration and diversification

A large, undiversified commitment to a single market can destroy a firm when that market turns against the position. A position concentration limit is a cap on how large any one holding can be relative to the account.

Diversification is spreading risk across uncorrelated markets so one blow-up does not dominate the book. Together with the leverage ceiling, that cap keeps one holding from deciding the fate of the account.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
8 of 15 in the Position concentration limit track
20071-1 pp.Next on Position concentration limitA first-trade survival sequence for leveraged futuresFor a new futures trader, remaining in the market after losses is the primary success test, because leverage can erase early gains unless exposure is bounded.
All readings on this track · 15 readings
  1. 1991Keep one risk ceiling after equity highs
  2. 1999Pre-trade size filters for expectancy and ruin
  3. 2000Budget the loss before entry with stops and position limits
  4. 2002Retest the entry before you exit
  5. 2002Option income after volatility and capital gates
  6. 2002Cap, scale, and delever when research buys late
  7. 2003Staying power starts as a planned-loser sizing rule
  8. 2006Leverage caps and concentration limits
  9. 2007A first-trade survival sequence for leveraged futures
  10. 2010Bound trend risk before the trade is placed
  11. 2011Event shocks, size caps, and second-order reweights
  12. 2014A copied scale-in ladder is not a personal risk plan
  13. 2018Worst-day caps for clustered system books
  14. 2019Pair-spread layer limits and event shocks
  15. 2020Pretrade quantity filters that bound account risk
By fieldSizing and leverage109 readingsBy year2006150 readings
All 16 readings tagged Position concentration limit
Also on Position concentration limit5 readings
1994Equal-weight holding count as a construction control1991Keep one risk ceiling after equity highs1999Pre-trade size filters for expectancy and ruin2000Budget the loss before entry with stops and position limits2002Cap, scale, and delever when research buys late