Position Sizing

Equal-weight portfolios ignore that a 1% position in a 40-vol crypto asset carries 8x the risk of a 1% position in a 5-vol bond ETF. Without volatility-aware sizing, portfolio risk is dominated by the noisiest assets.

The Problem

Signal-based strategies produce alpha scores, but scores are not position sizes. Naively allocating equal weight to every signal treats all assets as interchangeable. The result: a few high-volatility names drive total portfolio variance, drowning out the diversified signal you worked to build. Volatility targeting fixes this by scaling each position inversely to its risk.

The Pattern

WRONG

import numpy as np

# Equal weight: ignores that BTC vol >> SPY vol
signals = np.array([0.8, 0.6, 0.3, -0.5])
weights = signals / np.abs(signals).sum()  # [-0.36, 0.27, 0.14, -0.23]
# BTC at 40% vol gets same weight as SPY at 15% vol