Ask any algorithmic trader what kills a backtest in live markets and they'll pause, sigh, and say slippage. But dig deeper and the real culprit is almost always position sizing that ignores liquidity entirely. Fixed-lot models feel clean and simple — same size every trade, every day. Clean, yes. Realistic, absolutely not.
The ASX is not the NYSE. Daily dollar volume on a mid-cap ASX stock can swing 60% week to week. A fixed 10,000-share entry that works fine on a Tuesday might chew through three bid levels on a Thursday with half the usual volume. You're not just paying more — you're moving the market against yourself before the trade even starts.
Liquidity-adjusted sizing works by anchoring your position to a rolling average of daily traded volume — commonly the 20-day ADV. A typical constraint might cap any single entry at 5–10% of that ADV figure. Think of it like merging onto a motorway: you match the speed of traffic rather than flooring it and hoping everyone else adjusts. Small stocks get small positions. Liquid stocks get larger ones. The market decides the limit, not your conviction level.
The performance gap shows up most starkly in low-liquidity regimes — think small-caps, sector ETFs on quiet days, or any stock mid-earnings-blackout. Volume-scaled models naturally reduce exposure exactly when execution risk is highest. Fixed-lot models don't. They just quietly bleed. Researchers at the Journal of Trading have documented how transaction cost drag compounds across hundreds of trades into meaningful return erosion — not dramatic blow-ups, just slow death by a thousand cuts.
Implementing this today is simpler than it sounds. Pull a 20-day rolling ADV for each instrument in your universe, set a cap at 8% of that figure per entry, and let your execution logic handle the rest. For deeper reading on how market microstructure affects fills, Investopedia's liquidity explainer covers the fundamentals clearly. The mechanics of how order books thin out is well documented at Wikipedia's market liquidity page. And if you want the theoretical underpinning of volume-weighted execution, Investopedia's VWAP guide connects the concepts directly to live sizing decisions.
Your position sizing model is either your best risk manager or your worst enemy — and on the ASX, ignoring volume makes it the latter every single time.
This content is for educational purposes only and does not constitute financial product advice. Past performance is not indicative of future results. Profit Logic Ltd (ACN 688 669 936) accepts no responsibility for errors or omissions in this content or anywhere on this website. Always seek advice from a licensed financial adviser before making investment decisions.