Fixed Ratio Betting in Trading

Fixed ratio betting is a money management strategy used in trading to determine position sizing. 

This method tries to grow an account systematically while managing risk. 

Unlike most other position sizing techniques, fixed ratio betting adjusts position sizes based on account growth, allowing traders to potentially increase their profits as their account balance grows.

Key Takeaways – Fixed Ratio Betting in Trading

• Systematic Growth

• • Fixed ratio betting increases position sizes as your account grows.

• Formula-Driven

• • Use the formula: Units = Square root of (Account Balance / (2 * Delta)) to calculate position sizes.

• Delta

• • Choose your delta carefully. 
  • It determines how aggressively your position sizes increase. 
  • A smaller delta is more aggressive, while a larger delta is more conservative.

• Risk Management

• • The system ties position sizes to account balance, helping prevent overexposure during drawdowns.

• Complementary To Other Parts of Your Trading Plan

• • Fixed ratio betting enhances winning strategies but cannot turn losing strategies profitable. 
  • Combine it with solid trade selection and stop-losses.

Origins of Fixed Ratio Betting

It’s challenging to pinpoint the exact origin of fixed ratio betting, as the concept of increasing bets in proportion to account growth has likely been around for as long as gambling and speculation have existed.

But the formalization and popularization of fixed ratio betting as a specific strategy can be traced back to a few key sources:

Early Gambling Systems

Throughout history, gamblers have experimented with various betting systems to manage their bankrolls and potentially increase their winnings.

Some of these systems, such as the Martingale system, involve increasing bets after losses, which shares some similarities with the concept of fixed ratio betting.

Ryan Jones

A trader named Ryan Jones – via his 1999 book “The Trading Game” – is credited with developing and popularizing a specific fixed ratio betting method known as “The 10% Rule.”

This approach involves increasing position size by 10% for every 10% increase in account equity.

Jones sought to create a position sizing method that would allow traders to increase their position sizes as their accounts grew, without exposing them to excessive risk.

Futures Trading

Fixed ratio netting has found particular popularity in the futures trading community, where traders often use leverage and face high volatility.

The potential for rapid account growth in futures markets makes Fixed Ratio Betting an attractive strategy for those seeking to maximize profits.

Online Trading Communities

Online trading communities and forums have facilitated the sharing and discussion of various trading strategies.

How Fixed Ratio Betting Works

The core principle of fixed ratio betting is to increase position size incrementally as the account grows by a predetermined amount. 

This amount is called the “delta,” and it represents the profit required to increase the position size by one unit.

Key Components of Fixed Ratio Betting

1. Delta – The fixed amount of profit required to increase position size by one unit.
2. Units – The number of contracts, shares, or lots traded.
3. Account balance – The current value of the trading account.

The Fixed Ratio Formula

The formula to calculate the number of units to trade is:

Units = Square root of (Account Balance / (2 * Delta))

By tying the number of units to the square root of your account balance, you achieve a balance between aggressive growth during winning streaks and protection during drawdowns.

This formula is such that position sizes increase gradually as the account grows, rather than linearly or exponentially.

Implementing Fixed Ratio Betting in Trading

To implement fixed ratio betting in a trading strategy, follow these steps:

1. Determine your initial account balance
2. Choose an appropriate delta value
3. Calculate the initial number of units to trade
4. Adjust position size as the account balance changes

Choosing the Right Delta

A smaller delta will result in more aggressive position sizing, while a larger delta will be more conservative.

Factors to consider when choosing a delta:

1. Risk tolerance
2. Account size
3. Market volatility
4. Trading style and frequency

Example of Fixed Ratio Betting in Action

Let’s walk through an example to illustrate how fixed ratio betting works in practice:

• Initial account balance: $10,000 
• Delta: $1,000

1) Initial units = Square root of (10,000 / (2 * 1,000)) ≈ 2.24

Rounding down, the trader would start with 2 units of a particular asset – e.g., shares of a stock.

After a series of successful trades, the account grows to $12,000:

2) New units = Square root of (12,000 / (2 * 1,000)) ≈ 2.45

The trader would now trade 2 units, as the account hasn’t grown enough to warrant 3 units yet.

Once the account reaches $13,000:

3) New units = Square root of (13,000 / (2 * 1,000)) ≈ 2.55

At this point, the trader would round up to 3 units of whatever they’re trading.

Advantages of Fixed Ratio Betting

Fixed ratio betting offers several benefits to traders:

1. Systematic Account Growth

Increasing position sizes as the account grows means traders can potentially accelerate their profits without taking on disproportionate risk.

2. Risk Management

The system inherently manages risk by tying position sizes to account balance.

This prevents traders from overexposing themselves during drawdowns.

3. Flexibility

Traders can adjust the delta to suit their risk tolerance and trading style.

Accordingly, the system is adaptable to various markets and strategies.

4. Psychological Benefits

Fixed ratio betting provides a clear, objective framework for position sizing.

Like with every aspect of trading, it’s good to have systems in place to reduce emotional decision-making.

Disadvantages and Limitations of Fixed Ratio Betting

While fixed ratio betting has many advantages, it’s important to be aware of its potential drawbacks:

1. Complexity

Compared to simpler position sizing methods, fixed ratio betting requires more calculations and ongoing adjustments.

2. Potential for Overtrading

The system may encourage traders to increase position sizes too quickly.

This can lead to overtrading and increased transaction costs.

3. Market Disconnect

Fixed ratio betting doesn’t take into account market conditions or volatility, which may lead to inappropriate position sizes in certain situations.

4. Drawdown Impact

During prolonged drawdowns, position sizes can decrease a lot.

This can potentially limit the ability to recover losses quickly.

The key here is to develop a strategy (and potentially a hedging system) to avoid large drawdowns in the first place.

Comparing Fixed Ratio Betting to Other Position Sizing Methods

To better understand the merits of fixed ratio betting, it’s helpful to compare it to other common position sizing techniques:

Fixed Fractional Position Sizing

This method risks a fixed percentage of the account on each trade. 

While simple, it can start to lead to overly large positions in winning streaks and tiny positions during drawdowns.

Fixed Dollar Amount

Trading a fixed dollar amount per position is straightforward but doesn’t allow for account growth or drawdown protection.

Martingale and Anti-Martingale Systems

These systems involve doubling position sizes after losses (Martingale) or wins (Anti-Martingale). 

Both can be extremely risky and lead to large variance or account blowouts.

Tips for Successfully Using Fixed Ratio Betting

To maximize the benefits of fixed ratio betting while minimizing its drawbacks, consider the following tips:

1. Start Conservative

Begin with a larger delta to limit risk while you become familiar with the system.

If your position sizes create any type of emotion – excitement/relief when winning or annoyance/anger when losing – it’s a sign that position sizing needs to decrease.

2. Combine with Other Risk Management Techniques

Use stop-losses and proper trade selection in conjunction with fixed ratio betting.

3. Regularly Review and Adjust

Periodically look at your delta and overall strategy to make sure they still align with your goals and market conditions.

4. Use Technology

Use spreadsheets or calculators to automate calculations and reduce the potential for errors.

Fixed Ratio Betting vs. Fixed Fractional Betting in Trading

Both fixed ratio and fixed fractional betting are position sizing strategies used in trading to manage risk and potentially enhance returns. 

Because of their names, they are often confused as being the same type of betting strategy.

But they operate on different principles, leading to distinct outcomes and suitability for different types of traders.

Fixed Ratio Betting

• Principle – The position size increases in a fixed proportion to the growth of the trading account. For example, a trader might add one contract for every $5,000 increase in account equity.
• Outcome – This method tries to accelerate growth during winning streaks, as larger positions are taken when the account balance is high. Nonetheless, it can also lead to large drawdowns during losing streaks, as the position size remains relatively large even as the account balance decreases.
• Suitability – Fixed ratio betting is generally more suited to aggressive traders who are comfortable with higher risk and volatility in exchange for potentially greater returns. So risk management is, of course, important.
  

Fixed Fractional Betting

• Principle – The position size is determined as a fixed percentage of the current account equity. For example, a trader might risk 1% or 2% of their account on each trade.  
• Outcome – This method prioritizes capital preservation by adjusting the position size based on the account balance. During winning streaks, position sizes increase, allowing for greater profits. During losing streaks, position sizes decrease, limiting potential losses.  
• Suitability – Fixed fractional betting is considered a more conservative approach, suitable for traders who prioritize protecting their capital and managing risk. It’s often favored by those with longer-term trading horizons and a focus on steady growth.
  

Key Differences

Choosing the Right Strategy

The best strategy for you depends on your risk tolerance, trading style, and goals. 

Be sure to fully understand the implications of each method and how it aligns with your overall trading plan. 

Before making a decision, consider factors such as: 

• your experience level
• available capital, and 
• willingness to accept potential losses

Conclusion: Is Fixed Ratio Betting Right for You?

Fixed ratio betting offers a systematic approach to position sizing that can potentially accelerate account growth while managing risk. 

It nonetheless requires careful calculations, and ongoing monitoring to be effective.

Before considering fixed ratio betting, consider your trading experience, risk tolerance, and the characteristics of the markets you trade. 

It may be beneficial to paper trade using this system before using it with real capital.

Ultimately, the success of any position sizing method depends on the underlying profitability of your trading strategy. 

Fixed ratio betting can enhance a winning strategy, but it can’t turn a losing strategy into a winning one.