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Position Sizing Strategy for Forex Trading

Discussion in 'Forex Discussions' started by painofhell, Aug 27, 2015.

  1. painofhell

    painofhell Content Contributor

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    A crucial element of trading success is having a position sizing strategy for forex trading. Here is a position sizing strategy to help you maximize gains while minimizing losses.

    Position Sizing Strategy Step 1 – Determine your risk

    To determine our positions size we must first set a stop level. This should be a logical place which will be out of range of normal market movements, and if hit will be at a level where we know we are wrong about the direction of the market.

    Figure 1 shows a day trading example in the USD/JPY. Based on a number of failures to move higher, the price breaks below a short-term trendline, signaling a short trade. The entry price of the short is 97.76, and we place a stop just above the recent series of price highs (thick red line) at 97.84.
    [​IMG]

    We have our entry price and our stop, so we know our risk on the trade is 8 pips.

    Position Sizing Strategy Step 2 – Determine Percentage of Account to Risk

    No matter if your account is large or small-$1000 or $500,000–a single trade shouldn’t put more than 1% of the capital in your account at risk. On a $1000 account, that means you don’t risk more than $10 on a trade and you’ll need to trade a micro forex account. If your account is $500,000, you can risk up to $5,000 per trade, although at this level professional trades will risk even less 1% since there isn’t really a need to risk $5,000 per trade.

    Some trades may risk slightly more, especially if the account is small. This is not recommended, but if you do decide to risk 2% of your account on a trade, that means you can risk $20 on a $1000 forex trading account.

    Why only 1%? Even great traders can experience a string of losses when market conditions change. But if you keep risk below 1% per trade, even if you lose 10 trades in a row you still have almost all your capital. If you had risked 10% of your account on each trade, and lost 10 in a row, you’d be a wiped out. Also, even with risking less than 1% on each trade you can still make phenomenal returns. See: How Much Money Can I Make as a Day Trader

    Position Sizing Strategy Step 3 – Determine Position Size

    So on a $1000 forex trading account you can risk $10 (if only risk 1% of your account), and you know that your risk is 8 pips on the trade. That means you can take 1 mini lot (which is worth very close to $1/pip movement at this level) , or you can take 12 micro lots (about $0.10/pip). In the first example you are only risking $8, while the second example with 12 micro lots you are risking about $9.60.

    Therefore the optimal position size for this trade and account size is 12 micro lots. As you can see, with micro lots it is very easy to fine-tune position size. I recommend micro accounts to anyone with less than $10,000 in their account.

    If you have a $5000,000, you can risk up to $5000, but let’s assume you decide you’ll only risk $1000 on the trade. You have chosen a fixed dollar to risk, which is less than 1% of your account, so this is fine.

    Your risk is 8 pips and your can risk $1000. Trading standard lots each pip is worth about $10.30 at these levels, so if you trade 1 standard lot you are only risking $82.40. This is much less than the $1000 you are willing to risk. Trading 11 standard lots will result in a $988.80 loss if the stop is hit, therefore the optimal position size is 11 standard lots for this trade and account size.

    Position Sizing Strategy – Final Word

    This three step method allows you to find the ideal position size. When day trading you’ll need to be able to quickly calculate your position size as you are watching the market and spot trades. A rough estimate may sometimes have to do, but always bias yourself to a smaller position than a larger one. For example, if you have a $1000 account, and are making the trade shown above, in your head you can quickly calculate that you can take 10 micro lots. To find out you can actually take 12 may require a calculator. Therefore, just make the trade with 10 micro lots. Better to get a position, than to miss a trade because of messing around with a calculator.

    The method works for swing traders, day traders or investors. If your risk is 80 pips on a trade your position size will be smaller than if the risk is 8 pips, for example.

    Over time you should be able to quickly determine your position size as trade signals occur. So whether you risk 1% or less (recommended), or choose to risk a fixed dollar which is less than one percent of your account, these three steps provide you with the ultimate position sizing strategy fine-tuned for your account size and each trade.
     
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