What is Position Sizing and How to Calculate it
The position sizing, or trade size, is more important than your entry and exit when the forex day trading. You can have the best forex strategy in the world, but if trade size is too big or small, you will either take on too much or too little risk. The former scenario is more of a concern, as risking too much can evaporate the trading account immediately.
Your position sizing is how many lots you take on a trade. Your risk is broken down into the two parts trade risk and account risk. Here’s how all the elements fit together to give the ideal position size, no matter what the market situations are, what the trade setup is, or what strategy you are using.
1. Set Your Account Risk Limit Per Trade
It is the most important step for determining forex position sizing. Set a percentage or dollar risk limit, you will risk on each trade. Most professional traders risk 1% or less of their account.
Example: if you have a $20,000 trading account, you could risk $200 per trade if you risk 1% of your account on the trade. If your risk 0.5 %, then you can risk $50.
You can also use the fixed dollar amount, but ideally, this should be below 1% of your account. For example, you risk $85 per trade. As long as your account balance is above $8,500, then you have been risking 1% or less.
While other variables of trade may change, account risk is kept constant. Choose how much you are willing to risk on every trade, and then stick to it. Don’t risk for 5% on one trade, 1% on the next, and then 2% on another. If you choose 1% as your account risk limit per trade, then every trade should risk of 1%.
2. Determine Pip Risk on Trade
The maximum account risk is on each trade, now turn the attention to trade in front of you.
Pip risk on each trade is determined by the difference between the entry point and where to place your stop loss order. The stop-loss closes out the trade if it loses a certain amount of money. This is a way how risk on each trade is regulated, to keep it within the account risk limit discussed above.
When you make a trade, consider both the entry point and your stop loss location. You want your stop loss as close the entry point as possible, but not so close that the trade is stopped out before the move you are expecting occurs.
Once you know how far away your entry point is from stop-loss, in pips, you can calculate your ideal position size for the trade.
3. Determine Position Size for Trade
Ideal position size is a mathematical formula equal to:
Pips at Risk X Pip Value X Lots traded = $ at Risk
We know that the $ at Risk figure because this is the maximum we can risk on any trade (step 1). Also, we know the Pips at Risk (step 2). We also know the Pip Value of each current pair.
You can plug in any numbers into the formula to get the ideal position size. The number of lots the formula produces is connected to the pip value inputted into the formula. If you input the pip value of a micro lot, the formula creates your position size in micro lots. If you input a standard lot pip value, then you will get a position size in standard lots.
Proper position sizing is key. Establish a set percentage you will risk each trade; 1% is recommended. Then note the pip risk on each trade. Based on account risk and pip risk you can determine the position size in lots. Risk too little and your account does not grow, risk too much, and your account can be depleted in a hurry.