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 on CMT Level 2 under risk management (20% weight) and is essential for Level 3 essays.
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 essays — 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