Determining the volume of currency units to accumulate in a trade often appears to be confusing for novice forex traders. They tend to pick a random position size based on their level of confidence in a trade. Yet, experts claim that the most important aspect of building wealth in your portfolio is the position size of your trade. No matter how good your strategy is, if your position size is too large or too small, you’ll either take on too much or too little risk. And too much risk will deplete your savings in no time.
In day trading forex, the size of your position, or your trade size in units, is more important than the entry and exit point of your trade. In fact, it is the position sizing of a trade that is going to determine the speed and magnitude of the return that a trade will generate. In this article, we will take a close look at some of the controversial issues concerning ‘position size’ and how you can use them to your advantage.
What is a Position Size in Forex Trading?
In forex trading, position size refers to the number of units required to buy or sell a currency pair. It essentially signifies how much a trader is planning to spend on a trading portfolio.
Before initiating a forex trade, it is crucial that a trader understands their position size to help determine the exact number of units required to execute the trade.
Why understanding Position Sizing is crucial?
Position sizing is an important aspect of risk management. Risk management, as we’ve often heard, plays a vital role in determining whether or not a trader’s capital survives to see another day. A forex setup with this method can keep you from blowing your account up by taking on too much risk.
If you don’t know how to calculate your position size properly, you may end up taking trades that are too large for you. If even a few pips move against you in such a situation, your position becomes extremely vulnerable.
People usually say that "it's not what you have, but what you do with it that counts". But the truth is size does play a significant role when it comes to forex trading.
Let’s say that you have $1,000 in your forex account, and you’re taking on ten mini lots at a time. This will eventually lead to you going broke. One of the biggest mistakes that beginner forex traders make while entering a trade is entering the trade with an incorrect number of lots, often called “position size.”
The size of your trading position is determined by the type, size, and the number of lots you buy or sell in a trade. Standard, Mini, Micro, and Nano lots are the four types of lots in forex trading orders.
- A standard lot equals 100,000 currency units
- A mini lot equals 10,000 currency units
- A micro lot is 1,000 currency units
- A nano lot equals 100 currency units
If you are a newbie, you should never put more than 2% of your account at risk. For example, if you have $10,000 and keep your position size to 1%, you shouldn’t risk more than $100.
For instance, if you trade a mini-account (10k lots) using a 200:1 margin, you're only allowed to trade 2 lots.It is common for new traders to start increasing their position sizes as soon as they have a couple of profitable forex trades, which might end up as a very costly mistake. You must keep in mind that position size is a double-edged sword, and while it can make you big profits, it can also cause you to lose big.
If trades aren’t going your way, you should decrease, not increase, your position size.The second dumb move inexperienced traders make is to increase their position size right after losing trades in an effort to recover from their previous loss. It’s an even larger mistake because not only is the trader emotionally affected by the loss, but a larger position size could result in an account loss as well.
As you lose money from your trading account, you’ll have a harder time recovering those losses, and margin calls will come sooner. In general, the more money you have in your account and the smaller your position size is, the longer you will be able to trade forex.
How to Calculate Forex Position Size?
The following information will help you determine your position size:
- How much is your trading capital?
- What is the risk percentage that you are willing to take on?
- What is the distance between your entry price and stop loss?
- What is the pip value of the currency pair per standard lot?
Being familiar with the position size calculation is perhaps one of the first steps towards organized forex trading, an attribute of professional traders.
Here is an example calculation of forex position size:
Assume you have $10,000 in your account and do not mind losing 2% on a bad trade. In the case of USD/JPY, the stop loss is set at 50 pips for that trade. Let’s say that the current pip value per standard lot is $985.
Here is the formula for calculating your position’s size:
Position size = ((account value x risk per trade) / pips risked)/ pip value per standard lot
which is, ((10,000 US Dollars X 2%) / 50) / 9.85 = (200 USD / 50 pips) / 9,85 = 4 USD / 9,85 USD = 0.40 standard lots.
(4 mini lots or 40.000 currency units)
Similarly, if you were planning on opening several positions, you would use the same equation to limit the overall risk. The only difference is that a maximum number of open positions should be established beforehand, and each position should have a partial risk assigned to it.
Take, for instance, the same $10,000 account and limit the overall risk to 6%. You can now attribute a certain amount of risk to each trade until you reach 6% – after that, no new positions can be opened.
How to size your positions correctly to avoid over-risking?
Choosing the correct position size for your trade is crucial to achieving the right risk level. As a trader, you cannot achieve consistency without understanding how to size your positions, since sizing your positions inconsistently will lead to varying results.
Following these 2 simple steps will help you determine the right position size:
1. Establish Stop Loss Levels:
Starting with this point is always a good idea. Most traders approach position sizing incorrectly and set their stop loss level farthest out, resulting in significant losses.
Stop loss instills discipline in traders. In order to trade successfully, you need to know how the risk-return trade-off is going to work. You can only achieve this by setting your stop loss levels and profit targets well in advance.
Volatility in the market can also be mitigated by using stop losses. Since market volatility is an unavoidable fact, putting stop-losses when trading is the only way to minimize your downside risk. When you measure your potential loss using stop losses on all your open trades, you can see how much capital you have at risk. You are instantly notified if you need to cut your positions to reduce your risk based on that information.
2. Set a risk level for your trade:
What is the maximum amount of money you are willing to lose in the event of a stop loss? In most cases, traders risk a certain percentage of their accounts.
Make sure you do not simply buy a random position size and then adjust your stop loss based on the risk level you want. Stop losses must always be placed at reasonable price levels based on chart context. Additionally, your risk is determined by the quality of your trading setup; reducing risks on mediocre setups and increasing risks on good setups is called variable position sizing and is popular among professional traders.
Learn Top Forex Trading Techniques for Free!
The reason why some newbie Forex traders fail is that they attempt to run before they can walk. The fact that you are passionate about Forex trading does not mean that you should start trading right away. Just like any other business endeavor, Forex trading needs training too. It is a combination of theoretical education and practical training that makes a trader competent.
Make your Forex learning easier by checking out the wide range of Forex topics available through the AximTrade Forex course facilitated by a professional and get equipped with the knowledge you need to be successful in the global marketplace.
For those interested in starting out in live forex trading, copy trade could be an excellent place to start. Getting started with copy trade can make trading forex for beginners a lot more convenient as it reduces their chances of making costly mistakes and offers the possibility of learning forex trading from skilled and competent investors. Copy trading gives you a legit chance to hone your trading skills while also developing a wealth of knowledge.