Proper Position Sizing

 

Video Transcription:

Hey, traders. Welcome to Video 9 of the Forex Beginners Course. This is
Cory Mitchell. In this video we are looking at Proper Position Sizing
brought to you by Investoo.com.

So position sizing is one of the most important factors in long-term
trading success. It will either make you or break you. You are going to be
very hard pressed to find a successful trader who has lasted more than a
few years in the market who didn’t have proper position sizing down pat.

Ideally, you want to risk 1% or less, of your account, on a single trade.
The max is 2%. If you have a large account, you’re likely going to end up
risking less than 1%. So, if you have a $1 million account, risking 1%,
which is $10,000, on a trade, you’re probably not going to do that. You’re
probably going to be risking much less than that.

For smaller accounts, the tendency is to take too much risk. So they’ll
risk 5% to 10% of their own account on each trade, in an attempt to build
that account quickly. This is the completely wrong approach and will drain
your account very quickly.

You always want to risk 1%, 2% absolute maximum. That way, you’d have to
lose about a hundred trades in a row to even get down to the bottom of your
capital. And that assumes no winners. You’re going to have at least some
winners, even if you have no idea what you’re doing.

Just by random probabilities, you’re going to have at least a few winners
in there. So by risking 1% to 2%, you’ve basically eliminated the
possibility of getting your account blown out. What we call blown out is
when you lose all your money in a short amount of time.

So the amount at risk is the difference between your entry price and stop,
multiplied by the pip value and the number of lots. So in the next video,
we’re going to look at entries and stops. But for now, we need to know that
our entry price is where we’re getting in. Our stop loss is what we have
set our maximum, the price that we’re going to get out if the trade goes
against us. Multiplied by our position size, that is the number of lots
we’re taking.

So that is our risk. That is what this 1% or 2% is. I risk less than 1%,
some traders may decide to go up to 2% and that is what this risk is. So
it’s the difference between your entry price and stop multiplied by the pip
value. So the currency pair that you’re trading and the number of lots.

So let’s look at an example here. So, position size is 1%, so .01 of your
account size. So if you have a $5,000 account, that means your maximum risk
per trade is $50. The difference between your entry price stop times the
pip value and the lots must be less than this max risk. So in this case, if
your account is $5,000, whatever you’re risking on the trade must be less
than that $50, which is your max risk.

So let’s say you enter a trade in the EURUSD and place a 20 pip stop on it.
So you are entering the market at, let’s say, 136 and you think the price
is going to go higher, if it doesn’t, you’re willing to take a loss at
135.80 per 20 pips below.

So let’s do the mental math. I’m going to show you a formula in a second
but I want you to work it out a couple of different ways so that it sinks
in. So, you’re going to be able to do these things, these calculations very
quickly.

So let’s do the mental math. A EURUSD mini lot equates to $1 per pip. So a
20 pip stop means that you’re risking $20 if that price moves and hits your
stops, you’re going to have lost $20 on one mini lot. If you only lose $20,
that means you’re below your max risk, which is $50. So you still have more
money to play with.

If you take too many lots, so now each pip is going to cost you $2, and it
goes 20 pips against you, you’re going to be down $40. This is still below
your max risk, so you’re going to drop down to micro lots.

Micro lots are $0.10 a pip, so we have 20 pips times $0.10, so it’s going
to cost you $2 for each micro lot that you take, in terms of risk.
Therefore you still have $10 left over. Remember, we risked $40 already. We
have a maximum of $50 so we have $10 left over, which allows us to take 5
micro lots. So the ideal position size for this trade is 2.5 mini lots, or
you can think of it as 25 micro lots, whichever you prefer.

So this may seem complex but once you do it in practice, you’re going to be
able to come up with these precise position sizes. Even when making fast
paced day trades. So, originally this took a while for me to get used to.
But, day trading, swing trading and just doing it a lot, you’re going to
eventually be able to do it quite quickly.

So here is a simple formula. So your pips at risk is your difference
between your entry price and your stop, times your pip value, is going to
give you some number. Let’s just call it Y. Your total risk, which is the
amount that you can risk per trade. So that’s the 1% of your account,
divided by Y, will give you your position size. So you should always know
your total risk.

So this takes some of the math out of it. You should always know this. At
the start of each trading day, you look at your account balance. You know
what 1% is. And you know that that’s your max risk per trade.

So let’s say for example, you log in and your account balance is $3,300.
That means your max risk is $33. I’ll normally just stick with that
throughout the day. Even if my account balance may fluctuate up or down. A
couple hundred bucks, that doesn’t matter. It’ll just stay with that
number.

So, 37 pips risk, times $0.10. Let’s say we take this trade. It’s in the
EURUSD. And we see a set up and we want to put our stop 37 pips away. So we
have 37 pips of risk time $0.10, that’s the pip value of one micro lot in
the EURUSD. Which means, if we take one micro lot and our stock is hit, we
will have lost $3.70. So $3.70 is quite a bit below our max risk of $33, so
we can instantly tell we can take quite a bit more.

So all we have to do is divide our maximum risk by the risk of one lot. So
in this case it’s a micro lot. $33 divided by $3.70 equal 8.9 micro lots.
So, we can’t take 8.9 micro lots because a micro lot is the smallest
increment. But we can round it down to 8 micro lots that were under 1% or
we can round it up to 9 micro lots which would mean you’re just over 1%
risk. Still acceptable. So in that case, rounding up wouldn’t be too bad.

So as a general rule of thumb, if you have a large account, you’re going to
want to use mini or standard lots in this calculation. So, instead of using
$0.10 here, you would use $1. Because that’s what a min lot is. And in that
case, this number that it spits out will be in mini lots.

If you have a very large account, let’s say $1 million or more, or even a
few hundred thousand, you can put in $10, in this spot. And that means that
the number that gets spit out is going to be in standard lots. So you’re
going to be dealing in standard lots for the most part. So you can just
plug in $10 here instead of $0.10 to get your position size and standard
lots.

For most who are trading a small account, just always use $0.10 and that
will give you the number of micro lots you can trade. Easy to put in to
your software. And if you do need to convert it, let’s say you get 28 micro
lots. Just divide by 10 to get the mini lots. That’s 2.8 mini lots or 28
micro lots.

So this is the formula that you really need to understand. So your pips at
risk times your pip value. Each currency’s going to have a slightly
different pip value if the U.S. dollar is not the second currency listed.
So the EURUSD is always going to be $0.10 for a micro lot, $1 for a mini
lot and $10 for a standard lot.

If you switch in to other pairs, let’s say the GBP NZD or something like
that, that pip value is going to change slightly. It’s going to usually be
fairly close to this for most pairs. But it may change slightly. So you’re
going to want to check with your broker. Typically, they’ll have a sheet
that shows what the pip value is or how to calculate it.

And then this, you should always know your total risk divided by this Y
value to get your position size. So just get in to a demo account, practice
that as much as you can. Being able to calculate it quickly, if you need to
use a calculator, that’s fine. The point is that you want to always have a
proper position size that allows you to maximize your trades while also
controlling risks.

So, you don’t want to risk way less than 1% because you may not build your
account very quickly if you’re only risking a very small portion of your
account. But if you’re risking too much, let’s say 3, 4, 5, 6% on a trade,
a few losers and you’ve really drawn down that account.

So 1% to 2% is ideal. Calculate position sizes based on that. Go in to your
demo account. Put out some trades. Just practice calculating. Just make
some trades, eyeball them, we’re not actually trading. This is just an
exercise in position sizing. So just pick some trades, some random ones.
What would your stop be? Calculate out the position size.

Until next time, happy trading.

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