One of the most defining factors in any forex trade is the size of the trade or the position. So it is up to the trade to calculate precisely and correctly what the size of the trade ought to be. This is how you can control the amount of asset that you want to put up for trading, since the size of the position is, in essence, the amount or units of currency that you want to buy.
Furthermore, the trade size is also directly associated with the amount of profits you will potentially obtain and also the risks associated with any probable loss. So, given the importance of position sizing in forex, we want to delve deeper into this subject in this article and see how you can execute the perfect sizing and the risks that are inherent in it.
The Definition of Position Sizing in Forex
In simple terms, the size of a position is the number of currency units in a currency trading pair that you want to trade. Ergo, the size of your trade.
There are many factors involved in deciding the size of the trade, including the size of the account, the starting capital, and the maximum risk threshold for assets. Clearly, if things are ideal for any trader, they will naturally go for a bigger position size.
Determining the correct size of the position is crucially important as it is a major part of risk management in forex trading. So in order to minimize risks and maximize profits, calculating the correct size for your position is extremely important.
It is not very difficult to calculate the suitable position size for your trades. Although, it depends on many factors, including the pair you are trading, among others.
How to Calculate Position Size in Forex Trading?
In this article we will show you exactly how to calculate your position size. That’s right, calculate. There is a bit of math involved in it. But before going deep into numbers, digits, and decimals, let’s see what factors are relevant here.
In order to properly calculate the size of your position, the following factors are important – in the sense that they are the precursor or the perquisite to what your size will ultimately be.
Account size or starting equity
Naturally, the first and foremost deciding factor is the size of your account or the initial equity you have at your disposal. This amount will ultimately determine how much you can risk. If you are starting your trading career, you would probably be starting with much smaller capital. However, an experienced trader would have a much higher amount of equity to trade with.
The currency pair you want to trade
Secondly, the actual trading pair you have chosen for your trades can be defined in the final result of your position. Study the pairs carefully and find out as much as you can about them. Certain pairs are traded at a much higher rate and therefore have a higher trading volume. In fact, 5 trading pairs in the forex market account for more than half of all the trades undertaken in this financial market. You pick your pair with enough consideration.
Choosing the correct stop loss levels
Determining the stop loss level is among other precursors for calculating the position size. You can use various techniques and tools in order to pick the right level as your stop loss. The significance and importance of stop loss level should be taken into account in comparison with your entry price. Their relationship can determine your lot size. Such that if your stop loss is close to your entry price, then you can choose a bigger lot size and if the stop loss is farther from the entry price, then the lot size should be smaller.
Determine your risk threshold
As we discussed very early in this article, the position size is directly related to the amount of risk you are willing to take. Therefore, it is crucial to determine the maximum risk you can take – or rather the threshold of risk for your assets before entering a loss area. So we can define the risk threshold as the most amount of money you are willing and able to lose in trading. Most traders choose their risk threshold to be 1% of their account equity. Therefore, if you are trading with 5,000 dollars, then the maximum amount of money you are willing to risk losing in any given position would be $50 and not more.
Determining pip value
The pip value refers to the smallest amount of price movement for a currency pair in forex. The pip value depends on the size of your position. In a way that however big your position size is, there is a higher chance of losing assets per pip.
Calculating Position Size: Getting Down to Brass Tacks
Before calculating the position size, please keep in mind an initial factor: this calculation depends on whether your account currency or denomination is similar to the trading pair denomination or quote currency.
In our example we have taken that account and pair denominations are the same: the US dollar.
Now suppose we want to trade the ever popular trading pair, EUR/USD, and that you have deposited $1000 into your account.
As was discussed above, we do need certain initial data for the calculations. So we consider that we already have all the initial data.
Our account in this example has a risk threshold of 1% for each trade which is equal to 10 dollars. Further suppose that we risk 100 pips for each trade.
Now let’s do some calculations to figure out what our position size should be in order to avoid losses.
First, we need to divide the threshold of risk (the dollar figure) by the number of pips risked for each trade.
$10 ÷ 100 pip = $0.1 per pip
Then we need to consider the lost size and the pip value for it. If we consider our lot size to be a mini lot, ergo equal to one tenth of a standard lot size (100,000 ÷ 10 = 10,000). So for a lot of 10,000 units, the pip value would be $1 for each pip.
Now that we also have the lot size and the pip value for it, we can finally calculate the ideal position size with all the available data.
It is as follows:
$0.1 per pip × (10,000 ÷ $1 per pip) = 1,000 unit
The final figure that we obtain is 1,000 units. This is our ideal position size, which is equal to the maximum number of units or size of any given position without risking the loss of assets more than account tolerance.
Please keep in mind that there are also position size calculators available, which are essentially tools that enable you to input data and automatically obtain your position size.
Position sizing is an undoubtedly important step in forex risk management. Calculating the size of any position can determine the maximum units or amount that you can trade without risking too much equity. While there are tools and calculators available online for you to obtain the size of your positions, you can also calculate the position size yourself with a number of initial data including lot size, pip value, and account risk threshold.