Position Sizing Impact on Returns [TLT Iron Condor Backtest]
In this episode we use our new backtesting software to observe the effect different position sizing has on the returns of an iron condor.
I've said it for years, position sizing matters in a high probability system. Much more so than you would believe and today's show is the first in a new mini-series we are doing leading up to the launch of our new backtesting software. Inside we'll cover a case study using and iron condor backtest we ran on TLT including the impact on returns that altering the position size had on the portfolio.
Key Points From Today's Show:
Weekly Iron Condor in TLT
- Set the trade up to make weekly entries every 40 days, averaging 40 days to expiration.
- There may be some weeks that have no entries, and rarely any overlap between trades.
- Overall allocation in the first run was at 50%, which really impacts the profitability of the trade.
- There was no IV rank filter, and we just made as many trades as we could.
- Took profits at 50%, and there was no stop loss or adjustments.
- Selling the 20 delta calls on the short side, and the 20 delta puts on the short side, creating an expected 60% win rate.
Results:
- This iron condor lost compared to the S&P 500.
- It had a negative 67% return over the testing period.
- The number one reason why this trade lost was because of over allocation.
- Taking profits early, and IV's over expectation, we still won at 81%.
- The killer is the drawdown that was associated with high levels of allocation.
- The sequence of returns created an impossible situation to recover from.
*Much more important to have slow, steady gains in your portfolio as opposed to big swings and big movements in your account.
Tweaks and Adjustments:
- Reset the strategy and adjusted the overall allocation from 50% to 30%.
- Used the same exact setup - 40 days to expiration, no IV rank, taking profits at 50%, no stop loss, etc.
- Just entered fewer trades for the portfolio size -- instead of doing five tickers, do three.
Results:
- Went from a negative 67% return to a 6.86% return.
- The max drawdown was reduced to 45%, which happened in the middle of the cycle.
- This shows how important small tweaks in allocation can be, as well as the importance of not having large drawdowns early on in your portfolio.
- When your sequence of returns are not correct and you are over-allocated, so you lose early big, which sets you up for disaster.