Position Sizing in Forex

How to Calculate and Manage your Position Size in Forex Trading

Position sizing is a term used to connote the use of the right trade volumes for setting up a forex trade without exposing the trading account to too much risk. From this definition, it can be deduced that position sizing is a skill that every forex trader should possess, and use all the time.

Position sizing starts from the account size, then zeroes down to an understanding of trade volumes and lot sizes, and finally rounds off with the correct application of all this knowledge in setting up a correctly sized position in the forex market.

trading capital

Ideally position sizing is something that should be learnt on a demo account or better still, on a small real money account. It is actually preferable to start with a no-deposit real money account, just for testing purposes. Many brokers now offer this account. Get one with between $50 and $100 to practice what shall be discussed below.

The Starting Point: The Right Account Size

We may as well say it now. The fact that many brokers now offer traders the opportunity to open and trade accounts with as low as $50 does not mean you should. Lower capital requirements does not make it easier to profit; it actually makes it a lot harder and you will soon be shown why this is the case.

Nobody likes to work for peanuts. There is a saying that those who pay peanuts will get monkeys for workers. Another story talks about two monkeys who were given a banana each. The next time around, one of the monkeys was given more bananas, while the first one was given just one banana. While the second monkey relished his increased portion of bananas, the obviously angered first monkey threw his banana ration at the feeder.

The lesson here is this: if monkeys could get upset about being given far less than his mate, then you should obviously know that doing all the hard work in forex trading just to earn a few dollars or even cents per trade is absolutely not worth the trouble. You probably already know this. This is why many traders fall into the trap of trying to get too much from their meager account sizes. They assume too much risk and use position sizes that are way above what their small accounts can handle.

So there it is. Correct position sizing in forex starts with correct sizing of your trading capital to begin with. Frankly speaking, you should not start a real trading career with anything lower than $1000. If you must start with a small account, use it for the purposes of learning the ropes in the real money aspect of the market.

Know the Acceptable Risk Percentage

The risk percentage is the percentage of your trading capital that is used when a trade position is set up. It therefore follows that the risk to an account increases when

a)    The position size is high

b)    Leverage is high

c)     The number of active trade positions in the market is high.

You therefore want a balance of the three within the context of the appropriate risk element to the trade.

If you are a beginner, you would be served well if you stick to a risk percentage of not more than 3% of your account. Professionals may go up to 5%, but no more. This should include the cumulative lot sizes on ALL your active trades, and not just for each individual trade.

Knowing Where to Set the Trade Entry and Stop Loss

Risk to a trade account can also be defined by the stop loss. The stop loss should be set in such a way that whatever is the value of the SL (Stop Loss) in pips would not exceed 3% of your trading account. This means setting your stop loss points with clear guidelines. As much as possible, a stop loss on a long trade must be set below a support and a stop loss on a short trade should be set above the resistance.

This invariably means that the trader must set the trade in an appropriate place so that not too many pips have to be given away to the stop loss that has been set according to the rule given in the previous paragraph. If for some reason a large stop loss has been used, it must be offset by a commiserate reduction in the lot size of the position.

Trade the Appropriate Currency Pairs

Some currency pairs have only 2 pips as spread, while others have up to 10 pips as spread. Assets like gold will have spreads of up to 80 pips. You therefore need to know which currency pair to trade so as to allocate the right position size to the trade.

Do Not Overtrade

Overtrading in this sense means holding too many positions open. Not only does this put unnecessary strain on the account capital, it also stretches the leverage and ties up capital that could have been used for good trade setups in unnecessary positions. Sometimes we see traders holding up to 5 positions open. This is bad practice. It is better to patiently wait for good setups, and commit more capital to them than to open trades indiscriminately and stretch one’s account thin in doing so.

Conclusion

Position sizing calculators now abound on the internet. In this example, we showcase a trader who wants to go long on the EURUSD, with a stop loss of 50 pips when price is at market value. He is risking $150 which is 3% of his $5000 account. What should be his position size?

position sizing forex

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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