How to Determine Position Size When Forex Trading
Your position size, or trade size, is more important than your entry and exit when forex day trading. You can have the best forex strategy in the world, but if your trade size is too big or small, you'll either take on too much or too little risk. The former scenario is more of a concern, as risking too much can evaporate a trading account quickly.
Your position size is how many lots (micro, mini or standard) you take on a trade. Your risk is broken down into two parts--trade risk and account risk. Here's how all these elements fit together to give you the ideal position size, no matter what the market conditions are, what the trade setup is, or what strategy you're using.
Set Your Account Risk Limit per Trade
This is the most important step for determining forex position size. Set a percentage or dollar risk limit, you'll risk on each trade. Most professional traders risk 1% or less of their account.
For example, if you have a $10,000 trading account, you could risk $100 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 a fixed dollar amount, but ideally, this should be below 1% of your account. For example, you risk $75 per trade. As long as your account balance is above $7,500, then you'll be risking 1% or less.
While other variables of trade may change, account risk is kept constant. Choose how much you're willing to risk on every trade, and then stick to it. Don't risk 5% on one trade, 1% on the next, and then 3% on another. If you choose 1% as your account risk limit per trade, then every trade should risk about 1%.
Determine Pip Risk on Trade
You know what your maximum account risk is on each trade, now turn your attention to the trade in front of you.
Pip risk on each trade is determined by the difference between the entry point and where you place your stop loss order. The stop-loss closes out the trade if it loses a certain amount of money. This is how risk on each trade is controlled, to keep it within the account risk limit discussed above.
Each trade varies though, based on volatility or strategy. Sometimes a trade may have five pips of risk, and another trade may have 15 pips of risks.
When you make a trade, consider both your entry point and your stop loss location. You want your stop loss as close to your entry point as possible, but not so close that the trade is stopped out before the move you're expecting occurs.
Once you know how far away your entry point is from your stop loss, in pips, you can calculate your ideal position size for that trade.
Determine Position Size for Trade
Ideal position size is a simple mathematical formula equal to:
Pips at Risk X Pip Value X Lots traded = $ at Risk
We already know the $ at Risk figure, because this is the maximum we can risk on any trade (step 1). We also know the Pips at Risk (step 2). We also know the Pip Value of each current pair (or you can look it up).
All that leaves us to figure out is the Lots traded, which is our position size.
Assume you have a $10,000 account and risk 1% of your account on each trade. You can risk up to $100, and see a trade in the EUR/USD where you want to buy at 1.3050 and place a stop loss at 1.3040. This results in 10 pips of risk.
If you trade mini lots, then each pip movement is worth $1. Therefore, taking a one mini lot position will result in a risk of $10. But you can risk $100, so you can take a position of 10 mini lots (equal to one standard lot). If you lose 10 pips on a 10 mini lot position, you'll have lost $100. This is your exact account risk tolerance; therefore the position size is precisely calibrated to your account size and the specifications of the trade.
You can plug in any numbers into the formula to get your ideal position size (in lots). The number of lots the formula produces is linked to the pip value inputted into the formula. If you input the pip value of a micro lot, the formula will produce your position size in micro lots. If you input a standard lot pip value, then you'll get a position size in standard lots.