In forex terminology, an investor’s “position size” is the amount of currency they are using on a particular trade.
General received wisdom suggests that a larger position size means that, if a trade is successful, the returns will be higher – but by the same token, gambling with substantial amounts of money is a recipe for disaster if you’re not careful!
Because of this delicate balance, it’s key that traders understand how to gauge what size of position is best for them in any given situation – so let’s begin with the basics.
What is Position Sizing?
The phrase ‘position sizing’ refers to the number of units a speculator has put forward into a trade, usually expressed in terms of the number of lots or total value in dollars (or indeed the traders’ own default currency) once leverage has been taken into account.
Because forex involves a high level of risk by its very nature – and making at least the occasional bad trade is an inevitability – being able to assess the appropriate position size for your investments is central to any risk management strategy, and therefore a vital part of becoming a successful trader.
For instance, consistently erring on the smaller side will mean your profits aren’t as substantial as they could be, however it goes without saying that that regularly over-sizing your positions, especially when just starting out, can quickly lead to catastrophic financial losses!
Every trader (and each individual trade) is different, so in order to calculate the right position size for the situation at hand, it’s important to take into account several key pieces of information, which we’ll examine below.
How Do I Effectively Manage Risk When Position Sizing?
The first thing to consider when planning your trades is your account balance – or quite simply, how much money do you have set aside to trade with in the first place? If you’re a hobby trader who dabbles in forex in your spare time, for example, you’ll likely be using a small amount of expendable income (compared to professional investors who often work with comparatively larger lot sizes) and your expectations should be calibrated accordingly.
Whatever your account size, a common (and common-sense) risk management strategy to ensure you never blow your entire account in one go is to make an iron-clad rule for yourself by asking the important question: ‘how much of my account am I willing to risk on a single trade?’
Many retail traders set this level at 2%, though beginners could opt to go as low as 1% until they’re more comfortable; whatever you decide, just make sure you have the discipline to stick to it no matter how confident you are regarding a particular move! This means that if you start out with $10,000 in your account, you would only ever put $200 into any single trade once you’ve pledged to a maximum of 2% per position.
That way, if you’re only ever risking 2% of your account, you could make five disastrous trades in a row and only be down 10% from where you started – thereby insulating you from even the most unexpected of market reversals.
What Other Factors Should I Consider When Position Sizing?
Another key variable when deciding your position size is what stop loss level you’re comfortable setting; the lower you place it, the more margin you stand to lose before the position is closed – though setting it too close to the entry price means you run the risk of exiting the trade prematurely due to momentary dips (forfeiting any subsequent profit that could have been made).
In addition, it’s important to understand that no two currency pairs are alike, and your instrument of choice will itself bring several considerations to the table, including:
- What is the exchange rate of the pair I’m looking to trade?
- How liquid is the market for this pair?
- How confident am I regarding this pair’s current price movement?
How To Calculate Position Sizes
When calculating the most appropriate position size for your trade, the first step is finding out how much dollar you are able to risk without stepping outside of your self-imposed risk management limit.
For this example, let’s continue with the round figure $10,000 as your account size and suppose you’re looking to trade GBP/USD with a conservative 1% risk percentage:
Now we’ve established you’re able to place up to $100 on your latest Cable trade, we now need to calculate the value per pip, which is done by dividing this figure by the amount of pips you’re happy to risk – we’ll assume this is 200 pips for the sake of this illustration:
Our final step is to now multiply this value per pip in relation to a known unit-to-pip value conversion for GBP/USD – in this instance, we’ll trade a mini lot, where each pip is equivalent to $1 (though bear in mind that for standard lots, this would be proportionately increased to $10!):
…and there you have it – using this simple formula, the maximum position size you could responsibly put forward for your GBP/USD trade would be 5,000 units.
However, the mathematics gets marginally more complex if your account denomination is the same as the base currency (as opposed to the counter) – we’ll outline the process for such a case below.
Calculating Position Sizes with a Base Currency Denomination
This time, let’s assume we’re still trading GBP/USD with a 1% risk limit but with a £10,000 deposit; the calculation for finding out your maximum amount to risk would be the same (i.e. £100 as opposed to $100).
The difference is that we’d have to calculate this back into USD by applying the exchange rate to our maximum safe amount – as currency pair values are most often calculated in the counter currency – for simplicity’s sake, suppose the Set featured image exchange rate is an easy £1 to $1.5 conversion: