I am currently looking to design a trading system and am reading various literature on all aspects of this. One concept that has confused me a little is the % volatility model of position sizing (ps). My current understanding is based on the Van Tharp explanation and my issue is this.....
My ps approach is currently the % risk model and in my case 1R = 2%. This model makes sense to me because my ps is based on tech/analysis to set a stop-loss which using my 1R determines my maximum allowable position.
Van Tharp when describing the % volatility model shows how to determine the ps but there is no mention of a stop (other than the system's 20 day low stop). If for example the ATR is $1 and 1R = 2% and assuming capital of $100,000 I can allocate $2,000. $2,000 / $1 = 2000 shares. Let's say these shares are bought at $30 and at the time the 20 day low is $26. From what I understand (which I am not sure of) the stop is set at $26. Assuming that the stop is hit and I lose 2000 shares X $4 my loss and therefore risk when I entered the trade is $8,000 resulting in a risk of 8% rather than 2%.
Any confirmation of or correction in my understanding is much appreciated.