How to Answer “How do you size a position?” in Hedge Funds Interviews
In a position sizing hedge fund interview, “How do you size a position?” is a test of whether you can translate an investment view into a risk-controlled trade.
A strong answer shows a repeatable process: start from edge and downside, map that into a sizing constraint (risk, liquidity, portfolio fit), and explain the checks you run before you put risk on.
What Hedge Funds Evaluate When You Explain Position Sizing
In hedge fund technical interviews, this question is less about one “correct” formula and more about whether you can size with professional judgment. Interviewers want to hear that you separate conviction from risk budget, and that you can articulate what would make you reduce, add, or exit.
They’re also testing whether you understand risk management in hedge funds in practice: how sizing interacts with volatility, correlation, drawdowns, liquidity, and portfolio concentration. An analyst who can talk about sizing coherently is signalling they can protect capital, not just generate ideas.
Finally, it’s a communication test. Many hedge fund analyst questions are designed to force prioritisation under uncertainty. A good answer is structured, assumption-aware, and makes it easy for the interviewer to challenge a number (e.g., “2% position, 75 bps of risk, 3–5 day liquidity”).
Position Sizing Techniques and Risk Budgeting (Step-by-Step)
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Step 1: Start with the thesis, time horizon, and what “risk” means
Open by defining what you’re sizing: a trade expression of a thesis with a stated horizon (days vs months) and a clear risk unit. In most funds, “risk” is not notional—it's expected loss under adverse moves (often proxied by volatility, stress loss, or a stop level).
State the key inputs you need before you give a number: (1) base case and bear case, (2) catalyst/timing, (3) what invalidates the thesis, and (4) the liquidity you have. This sets up the idea that sizing is a function of downside and probability-weighted outcomes, not just “I like it a lot.”
If relevant, clarify whether you’re discussing gross exposure, net exposure, or “risk-weighted” exposure. That one sentence signals you understand how different pods/funds talk about sizing.
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Step 2: Convert downside into a position limit (stop-based and/or vol-based)
Give one primary sizing technique and one cross-check. Common position sizing techniques include:
- Stop / thesis break sizing: choose a thesis break level (hard stop or reassessment level), estimate loss to that level, and set size so that loss equals a pre-set risk budget (e.g., 50–100 bps of NAV per idea).
- Volatility / VaR-style sizing: size so that the position contributes a target amount of daily/weekly risk, using realised/implied vol and an assumed move (or a simple VaR proxy).
Make the math intuitive rather than overly detailed: Size = risk budget ÷ expected adverse move to stop. Then add what you do when the stop is “soft” (e.g., scale down size or require more diversification/catalyst clarity).
Call out that you adjust for gap risk (events, earnings), borrow/financing, and nonlinear payoffs (options) because the stop may not be executable at the stop price.
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Step 3: Apply portfolio constraints: concentration, correlation, and factor exposure
Next, show portfolio construction awareness: even a “good” standalone size may be wrong in the portfolio. Explain how you cap or haircut size based on:
- Concentration limits: max % NAV by single name, sector, theme, or catalyst bucket.
- Correlation and factor overlap: if the idea loads on the same factors as existing positions (rates, oil, momentum, China beta), you size smaller or offset elsewhere.
- Gross/net and drawdown limits: the fund’s risk budget is dynamic—if you’re near limits or volatility is rising, you reduce sizing across the book.
This is where you demonstrate investment strategies awareness: sizing isn’t just about a single expected value; it’s about how incremental risk improves the portfolio’s return distribution.
A crisp line that plays well in interviews: “I’m sizing the marginal contribution to portfolio risk, not my enthusiasm for the idea.”
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Step 4: Liquidity and implementation: can you enter/exit without owning the market?
A hedge fund answer should include implementation realism. Explain how liquidity constrains size via:
- Days to exit at a reasonable participation rate (e.g., 10–20% of ADV) under normal conditions and under stress.
- Bid–ask and slippage, especially for small caps, credit, or crowded shorts.
- Borrow availability and recall risk for shorts.
Then show how you translate that into a cap (e.g., “I want to be able to exit within 3–5 days without materially moving price”). If the trade is catalyst-driven (earnings, FDA, M&A), mention you’ll reduce size into binary events unless the structure is asymmetric (options) or you can define the loss.
This step distinguishes a textbook answer from a real hedge fund approach to position sizing.
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Step 5: Ongoing sizing rules: add, trim, or exit based on new information
Close the framework by explaining how size evolves. Interviewers like to hear explicit decision rules:
- Add when the thesis is confirmed, the catalyst path is clearer, and risk/reward improves (or when price moves in your favour and the stop can be tightened without increasing risk).
- Trim when upside is realised, when the position becomes a large contributor to portfolio risk, or when the market starts paying you less for the same risk (multiple expansion, vol compression reversal risk).
- Exit when the thesis is impaired, when the catalyst is delayed beyond your horizon, or when the position violates predefined risk limits.
Mention at least one sanity check: stress test a few scenarios (market sell-off, sector shock, rates move) and ensure the position doesn’t create an unacceptable drawdown or hidden factor bet.
This shows you treat position sizing as a process, not a one-time number.
Model Answer for Hedge Fund Technical Interviews (Analyst)
I size a position by converting my view into a risk budgeted trade, then checking it against portfolio and liquidity constraints.
First I define the thesis and horizon, and I’m explicit about what invalidates the idea. I’ll set a thesis-break level or scenario that represents the downside I’m willing to take if I’m wrong. Then I translate that into size: I pick a risk budget per idea—say 50–100 bps of NAV in a typical market environment—and I size so that the loss to the stop or bear-case move equals that budget. As a cross-check, I look at volatility-based sizing so the position’s risk contribution is consistent with the rest of the book.
Next I apply portfolio constraints: I haircut size if it increases concentration or if it overlaps heavily with existing factor exposures. Even if I love the idea, I don’t want it to be a hidden bet on one macro driver.
Finally I cap size by liquidity and implementation. I want to be able to exit in a few days at a sensible participation rate, and for shorts I also consider borrow availability and gap risk around events.
After entry, sizing is dynamic: I add when the thesis is confirmed and I can tighten risk, and I trim when the position becomes a disproportionate driver of portfolio risk or when upside is largely realised. That way the position size reflects edge, defined downside, and overall portfolio risk management.
- Lead with “risk budgeted trade” to show a hedge fund mindset.
- Name a primary method (stop-based or vol-based) and a cross-check.
- Explicitly mention correlation/factor overlap—this is often the differentiator in hedge fund technical interviews.
- Include liquidity/ADV and gap risk to make the answer real-world.
- End with clear add/trim/exit rules to show process discipline.
Common Mistakes in Hedge Fund Analyst Questions on Sizing
- Giving a single notional % without tying it to downside, a stop/thesis break, or a risk budget.
- Talking only about conviction (“high/medium/low”) and ignoring correlation, factor exposure, and concentration.
- Ignoring liquidity realities (ADV, slippage, borrow) and event-driven gap risk.
- Overusing complex metrics (VaR, Kelly) without explaining assumptions and practical constraints.
- Describing sizing as static—no plan for how you add, trim, or reduce risk as information changes.
- Forgetting the portfolio context: a good idea can still be too big given current gross/net or drawdown limits.
Follow-Ups: Portfolio Risk Management and Investment Strategies
Do you use the Kelly criterion for position sizing?
I view Kelly as a theoretical reference for edge vs variance, but in practice I use fractional sizing with hard constraints (drawdown, liquidity, concentration) because estimates of win rate and payoff are noisy.
How do you think about sizing around earnings or binary catalysts?
I reduce size unless I can define the loss (options or tight risk) because stops may not work on gaps; I also stress the move versus implied volatility and my portfolio’s exposure to the outcome.
How do you size a position in a long/short equity book versus a macro book?
In L/S equity I emphasise single-name downside, factor overlap, and liquidity; in macro I focus more on scenario/stress loss, convexity, and how the trade behaves across regimes.
What would make you cut a position quickly versus give it more room?
If the thesis is invalidated or the market is moving for reasons that break my edge, I cut quickly; if the thesis is intact but timing is off, I may reduce to a “keep-alive” size within my risk budget.
How do you prevent one position from dominating portfolio risk?
I monitor marginal risk contribution (vol/stress), set concentration caps, and trim when correlation spikes or when the position becomes the largest driver of drawdown in stress tests.
How to Practise for Hedge Fund Interview Prep on Position Sizing
- Build a 90-second version: thesis → downside/stop → risk budget → portfolio & liquidity checks → resize rules.
- Practise with two concrete examples (one liquid large cap, one less liquid or catalyst-driven name) so you can show how sizing changes.
- Memorise 3–4 “numbers you can defend” (e.g., risk per idea in bps, days-to-exit range, concentration cap) and explain they vary by fund.
- In AceTheRound, rehearse delivering your answer, then ask for feedback specifically on: clarity of assumptions, portfolio thinking, and whether your sizing logic is falsifiable.
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