A backtest that earns 10% on a small account does not establish that it can earn 10% on a large fund. Larger positions demand more liquidity, take longer to trade and may exhaust the securities available to borrow. This lesson extends financing, borrow and transaction costs into a capital-dependent simulation. It derives a participation bound, separates an economic capacity limit from an operational one, and shows why scaling requires rerunning the portfolio policy.
Learning objectives. By the end of this note you should be able to:
- define strategy capacity relative to a capital convention and performance hurdle;
- calculate order participation and an instrument-level capital bound;
- derive how a nonlinear impact assumption changes expected net return;
- distinguish average-return capacity from the capital that maximises expected profit;
- design stress scenarios that include slower fills, unavailable borrow and reduced liquidity.
In this lesson
- Start with the order the market must absorb
- A first bound on deployable capital
- Impact makes percentage costs depend on size
- Capacity is not the same as maximum profit
- Rerun the strategy at each scale
Before you start
The full lesson, with worked examples and exercise solutions, is for members.
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