[Red Envelope] Attack and Defense Taoism Practical Knowledge — Trend Trading Series [Position Sizing]

Why do you lose money even when you’re right about the direction? [Taogu Ba]
Many people have experienced this: they are confident about a stock, analyze it thoroughly, but only buy 1 lot. As a result, it rises 50%, and they regretfully slap their thighs: “If I had known, I would have gone all in!”
Another stock, equally promising, this time with full confidence, they go all in. But it drops 10%, and they start to hesitate about whether to cut losses, eventually it falls 30%, trapping them deep.
Even when you are right about the trend, why do the outcomes vary so greatly? Because the ultimate determinant of profit is not how many times you are right, but how much you buy when right and how much you lose when wrong.
This is the significance of position management.
Core idea: Trend trading without position management is essentially gambling. You may be right about the trend, but if your position is too small, you won’t make money; if your position is too large when wrong, you risk big losses. Position management is the only bridge turning “being right” into “making money.”

【Today’s section is also basic knowledge, a fundamental concept in trend trading. When combined with short-term trading, it has important reference value, but it is not a rigid copy.】

1. The Rule of Matching Certainty with Position Size

1.1 What is “certainty” in trend trading?

Note that this is fundamentally different from the certainty discussed in right-side trading.
In trend trading, certainty is not an absolute value but a relative concept. Some signals are more reliable than others, some market environments are more suitable for long positions than others. According to your rules, you can assign different “certainty levels” to different situations.
Based on the definition of trend from the first article, we can introduce two dimensions—indices and sectors—to evaluate certainty. Because the trend of individual stocks is not isolated; it is influenced by the overall market and the sector it belongs to.

1.2 Certainty grading standards

I evaluate the certainty of a trade based on three dimensions:
Index trend: Is the Shanghai Composite Index (or your main reference index) in an upward trend? (defined by the 20-day moving average)
Sector trend: Is the sector index of the stock in an upward trend? (also defined by the 20-day moving average)
Individual stock trend: Is the stock itself in an upward trend? (as defined in the first article)
Based on these three conditions, certainty is divided into four levels:

Note on sector trend judgment: A stock may belong to multiple sectors, such as “AI computing power” and “Semiconductors.” For consistency, it is recommended to use the sector index most relevant to the company’s main business or the one with the highest recent correlation as a reference. If uncertain, observe which sector’s stocks are leading when the stock hits a limit-up or surges significantly; that sector is its main affiliation. In practice, you can also use the default industry classification in your trading software (such as Shenwan first-level industry) and stay consistent. The key is consistency, not perfect accuracy.

Logic of weights among index, sector, and stock:
The index represents the overall market environment, determining systemic risk;
The sector indicates capital concentration direction, affecting sector effects;
The individual stock is the specific target.
When the index declines, even if the sector and stock are strong, they may be dragged down by the market (high risk of counter-trend correction), so the index has the highest weight.
When the index fluctuates or rises, sector effects become the main driving force.
Therefore, an index rising + stock rising (Grade A) is more reliable than sector rising + stock rising (Grade B), because the former has the index as a support, while the latter may be dragged down by the index. This weight distribution is based on the principle of “systemic risk priority.”

1.3 Position size matching rules

Based on the certainty level, set recommended position ranges:

Note on numbers: The position figures provided here are empirical suggestions, derived from the risk control principle that “any single loss should not exceed 2% of total capital.”
Suppose a stock’s stop-loss is 5% (distance from purchase price to the 20-day moving average). When the position is no more than 10%, the maximum loss per trade is 0.5% (10%×5%).
If the position is 15%, the same 5% stop-loss results in a 0.75% loss, still manageable but increasing volatility.
You can adjust according to your risk tolerance, but the core principle is: Position size should match certainty, ensuring any single loss does not exceed your risk capacity.

2. The Mathematical Principle of Scaling into Positions

Even if you set a maximum position limit for a stock (e.g., 20%), you should not buy all at once. Because you never know if the price will immediately pull back after entry. Scaling in smooths out costs and reduces decision pressure.

2.1 The Standard Pyramid Building Method

The meaning of pyramid building is: As the stock price rises (trend confirmed), gradually add to the position; initial position is the largest, subsequent additions decrease.
Standard mode (using a total position cap of 20% as an example):
First batch (initial position): Buy when the signal appears, with 8% of total capital
Second batch (add-on): When the price has risen more than 8% from the first buy and the close remains above the 20-day moving average, add 6%
Third batch (final addition): If the price continues to rise and another buy signal appears (e.g., pullback to the 10-day line or another 8% increase), add 6%
At this point, total position reaches 20%, no further additions.

Quantitative conditions for adding:
8% is an empirical value (adjust as needed in practice); too small leads to frequent additions in oscillations, too large may miss some gains.
You can also combine signals like a pullback to the 10-day line, but the simplest and most reliable method is to trigger on fixed percentage increases, keeping rules simple.
Why pyramid and not reverse pyramid?
Because later, although the trend is clearer, the stock price is higher, and the risk-reward ratio decreases.
A heavier initial position ensures enough exposure during the early main upward wave to enjoy gains.
If the first buy drops, you only lose a small position, making it easier to cut losses.

2.2 The Risks of Anti-Pyramid (Inverse Pyramid)

Many are used to adding positions like: buy 10%, then buy 20% on a dip, then 40% on further decline. This is “averaging down,” but its mathematical essence is: making losing positions larger.
Suppose you buy at 10 yuan (8% position), then on a drop to 9 yuan, you add 12% (total 20%). The average cost drops to 9.4 yuan, but your position is now 20%.
If it falls further to 8 yuan, your loss is much larger than the initial stop-loss. This violates the principle of “cutting losses,” effectively letting losses run.
In contrast, the pyramid method: Add only when profitable, never when losing. This aligns with “letting profits run.”

2.3 The Mathematical Advantage of Scaling in

Suppose a stock ultimately gains 30%, but with fluctuations. Buying full position at once (20%) might cause you to be shaken out or suffer psychological stress. Scaling in allows you to:
First batch (8%) at the start, even if it pulls back, you won’t panic because the position isn’t large.
Second batch (6%) after trend confirmation, with a slightly higher cost but more certainty.
Third batch (6%) during trend acceleration, with the highest cost but capturing the final move.
The average cost will be between the lowest and highest, and holding throughout is more stable.
More importantly, if the trend fails, the first batch (8%) can be stopped out with minimal loss, avoiding heavy damage.
This is the core advantage of scaling in: Use partial gains to ensure safety, small losses for big profits.

3. The Upper Limit Rules for Positions

Besides individual stock position limits, overall risk control includes maximum per-stock, sector, and total portfolio.

3.1 Single-stock position limit

No matter how certain, any stock’s position should not exceed 20% of total capital (25% for aggressive traders). This is an iron rule.
Why?
Trend trading is fundamentally a left-side strategy, with lower certainty than right-side strategies, requiring diversified positions to avoid concentration risk.
If you are wrong, losses are controlled. Even a -10% drop affects only 2% of total capital.
Prevents overconfidence in a single stock, avoiding emotional trading.
Volatility adjustment: The above suggestion applies to stocks with normal volatility (e.g., daily amplitude within 5%).
For high-volatility stocks (like ChiNext or STAR Market stocks), reduce the single-stock limit to 10-15%, as the same stop-loss results in larger actual losses.

3.2 Sector position limit
Within the same sector, total position should not exceed 50% of total capital.
Why?
Stocks in the same sector tend to move together; concentration in one sector means no diversification.
When the sector faces negative news, all holdings are affected.
Limiting sector exposure prevents excessive risk in hot sectors.

3.3 Total portfolio limit
Set the total position limit based on index trend:

Understanding total position limit:
It is an “upper bound,” not a “must reach.”
Only when opportunities matching the certainty level appear do you gradually build positions.
If no sufficient opportunities, keeping the overall position below the limit is normal.
Avoiding overtrading is a core principle of position management.

4. The Inspiration from the Kelly Formula

In mathematics, the Kelly formula is used to calculate “how much to bet when knowing the win rate and odds.”
Although in trading we can’t know exact win rates and odds, this formula gives an important conclusion: in trend trading, no single trade should be full position.
It shows that even with a 50% win rate and a 2:1 reward-to-risk ratio (profit 10%, loss 5%), the optimal position size is about 25%.
If your win rate drops to 40%, with the same ratio, the optimal size is about 10%.
This explains why experienced traders emphasize “position control”—full position assumes 100% win rate, which is impossible in markets.
The key takeaway from Kelly:
Don’t try to go all-in; full position will eventually come back to bite you.
Match your position size to certainty; higher certainty (higher win rate, better reward-risk ratio) allows slightly larger positions, but always leave room.
Our usual 10% limit per trade is based on this logic—prefer to earn less but survive longer.
You don’t need to memorize the formula; just remember these principles.

5. Simulation Cases

5.1 Case 1: S-level certainty (total position 20%)

Background: After a trading day closes, you review:
Index is in an uptrend (closes above 20-day line, 20-day line rising)
Sector A is in an uptrend (also above 20-day line)
Stock X in Sector A has high volume and breaks above the 20-day line, with the 20-day line turning upward
Certainty level: S (triple resonance)
Position plan:
Single stock limit: 20% (per S level)
Scaling in:
First batch: 8%
Second batch: 6% (after price rises more than 8% from first buy and remains above 20-day line)
Third batch: 6% (if trend continues, another buy signal, e.g., pullback to 10-day line or another 8% increase)
Total: 20%, no more additions.

Execution:
Day 1: Buy 8% at 10 yuan. Stop-loss at break of 20-day line (~9.8 yuan).
Day 7: Price rises to 11.0 yuan (+10%), after pullback to 10-day line, add 6% at 11.0 yuan. Total position 14%. Stop-loss moves up to ~10.7 yuan.
Day 15: Price reaches 12.1 yuan (+21%), another buy signal (e.g., +8%), add 6% at 12.1 yuan. Total 20%. Stop-loss moves up to 11.8 yuan.
Day 22: Price peaks at 13.2 yuan, then drops to 11.9 yuan, breaking below 12.0 yuan (20-day line). Trigger stop-loss, sell at ~11.9 yuan.

Profit calculation:
First batch: profit (11.9 - 10)/10 = 19%, contribution: 8% × 19% = 1.52%
Second batch: profit (11.9 - 11.0)/11.0 ≈ 8.18%, contribution: 6% × 8.18% = 0.49%
Third batch: loss (11.9 - 12.1)/12.1 ≈ -1.65%, contribution: 6% × (-1.65%) = -0.10%
Total profit: 1.52% + 0.49% - 0.10% ≈ 1.91% (of total capital)
Considering transaction costs (~0.15% per side), actual profit around 1.76%.
Despite the last batch being slightly unprofitable, the overall profit is significant, demonstrating the advantage of scaling into a trend.

5.2 Case 2: B-level certainty (position 10%)

Background: In another scenario, you observe:
Index is in a consolidation (oscillating around 20-day line, line flat)
Sector B is in an uptrend (above 20-day line, line rising)
Stock Y in Sector B has just stabilized after a pullback to the 20-day line
Certainty level: B (moderate certainty)
Position plan:
Single stock limit: 10% (per B level)
Buy all at once: 10%
Execution:
Day 1: Buy at 20 yuan. Stop-loss at 19.5 yuan (below 20-day line).
Day 8: Price rises steadily to 22.5 yuan (+12.5%), no break below 20-day line.
Day 12: Peaks at 23 yuan, then pulls back, closing at 21.8 yuan (>20-day line).
Day 15: Closes at 21.2 yuan, below 21.4 yuan (20-day line), triggers stop-loss, sell at ~21.2 yuan.

Profit:
(21.2 - 20)/20 = 6%, contribution: 10% × 6% = +0.6%
Minus transaction costs (~0.15%), net about +0.45%.
Result: In a consolidation environment, relying on sector effect, the stock gains 6%, contributing 0.45% overall.
Comparison of the two cases

Key points:
Same rules, different certainty levels, different positions, and outcomes vary greatly.
High-certainty trades, through scaling, can generate substantial profits; moderate certainty yields moderate gains; low certainty results in small or no losses.
This is the essence of position management: bet more on high-probability events, less on low-probability ones. Over time, the mathematical expectation is positive.

6. Common Questions and Answers

Q1: I bought the first batch according to the rules, it rose, and now I regret not going all in. What should I do?
A: This is “result bias.” You see it rose this time, so you think going all in is better. But if you go all in and encounter a false breakout, losses can be huge. Scaling in is about trading potential gains for safety. Long-term, surviving longer is more important than quick gains.

Q2: Isn’t the position limit too conservative, causing me to earn less in a bull market?
A: In a bull market, indices and most sectors are rising, and many of your trades are S or A level, with diversified stocks, total positions can reach 80%, which is not conservative. Plus, in a bull market, win rate is high, so your positions naturally increase. The rules are dynamically adaptive. Also, 20% is a flexible “overnight” position; intraday, you can reach 100%.

Q3: If multiple S-level opportunities appear simultaneously, how to control total position?
A: The total position cap of 80% is a strict constraint. If multiple S opportunities occur, you can allocate positions accordingly, but individual stock and sector limits still apply. For example, if you have four S-level stocks, you can distribute the total 80%. If opportunities are too many, prioritize the best or skip some.

Q4: How to handle high-volatility stocks (like ChiNext) in terms of position?
A: High-volatility stocks may require larger stop-loss margins, so reduce position size accordingly. For example, lower the single-stock limit from 20% to 10-15% to better control risk.

Q5: Must I strictly follow the 8% increase rule for scaling in?
A: 8% is an empirical value; you can adjust based on personal preference and stock volatility, e.g., 5% or 10%. The key is to have clear rules and follow them consistently. Using pullbacks to the 10-day line is also feasible but introduces subjective judgment. Beginners should start with fixed percentage rules.

Q6: The whole system lacks backtesting validation. How can I trust it?
A: The system provided is a logically consistent risk management framework, not a stock picking secret. You can backtest or simulate to see if it suits you. The effectiveness depends on discipline and market conditions. No system guarantees profits forever, but rules based on probability and risk control help you survive long-term.

Position management is the most tedious and counterintuitive part of trading because it doesn’t bring quick riches. But it is the foundation of long-term profitability. Trust mathematics, not feelings.

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