Position Sizing on the CMT Exam
Position sizing determines how much to risk per trade — arguably more important than entry/exit signals. It is tested in Level II application and risk-management contexts and is essential for Level III short answers.
For the full overview, see the CMT Exam Guide 2026.
The Percent Risk Model
The most widely taught position sizing method:
Position Size = (Account Risk × Account Size) / (Entry Price − Stop Price)
Example: $100,000 account, 1% risk, stock at $50 with stop at $48:
- Risk per share = $2
- Position size = ($1,000) / ($2) = 500 shares
Key Parameters
| Parameter | Conservative | Moderate | Aggressive |
|---|---|---|---|
| Risk per trade | 0.5% | 1–2% | 3–5% |
| Max portfolio heat | 3–5% | 6–10% | 10–20% |
| Correlated positions | 2–3 | 3–5 | 5+ |
| Max drawdown expected | 5–10% | 10–20% | 20–40% |
Fixed Fractional Method
Risk a fixed fraction of current equity on each trade:
- As equity grows, position sizes increase
- As equity shrinks, position sizes decrease (natural defense)
- Anti-martingale: Bet more when winning, less when losing
- Opposite of martingale (doubling down on losses — dangerous)
Kelly Criterion
The mathematically optimal fraction to maximize geometric growth:
Kelly % = W − [(1 − W) / R]
Where: W = win probability, R = win/loss ratio
- Full Kelly: Theoretically optimal but volatility is extreme
- Half Kelly: Commonly used — reduces volatility by ~50% while keeping ~75% of growth
- Requires accurate estimates of win rate and payoff ratio from backtesting
Optimal f (Ralph Vince)
More sophisticated than Kelly — finds the optimal fraction by testing all possible fractions against the actual trade distribution. Key insight: the fraction that maximizes terminal wealth may create unbearable drawdowns.
Portfolio Heat
Total risk across all open positions:
- Portfolio heat = Sum of individual position risks
- Should not exceed 6–10% of equity
- Correlated positions amplify risk (intermarket analysis helps identify correlations)
Risk of Ruin
The probability that a sequence of losses will deplete the account:
- Depends on: win rate, payoff ratio, risk per trade
- At 1% risk per trade with 50% win rate and 2:1 payoff, risk of ruin ≈ 0%
- At 10% risk per trade with same stats, risk of ruin ≈ 30%
This connects to trading psychology — large losses cause emotional damage beyond financial loss.
Position Sizing & System Performance
The same trading system can produce vastly different results depending on position sizing:
- Conservative sizing = smooth equity curve, lower returns
- Aggressive sizing = volatile equity curve, higher potential returns but real drawdown risk
- The "right" size depends on risk tolerance and investment objectives
CMT Exam Application
- Level 2: Calculate position sizes, understand Kelly criterion, risk of ruin
- Level 3: Integrate position sizing into portfolio management short answers — demonstrate understanding of trade-offs
Practice position sizing calculations in our test bank. Full guide: CMT Exam 2026.
Risk of Ruin — Impact of Risk Per Trade
Probability of account depletion increases exponentially with higher risk per trade
Kelly Criterion — Full Kelly vs. Half Kelly Equity Curves
Half Kelly achieves ~75% of the growth with ~50% of the volatility