Determining Proper Position Size in Forex Trading

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Determining Proper Position Size in Forex Trading

Part of money management, position trading and position sizing in Forex determine the profitability of a trading account. Many try, few succeed.

Traders bear enormous responsibility. From the moment they fund the trading account, suddenly become money managers. Like it or not, this is the reality.

However, managing money is not for everyone. Traits must exist. Skills better be in place.

Because Forex trading won’t forgive any mistakes, traders must master position trading. Hence, the direction of a trade is one thing. Position sizing in Forex is another.

Once again, it all comes down to the money management. Because even the best strategy fails, this article will treat how to avoid making rookie mistakes in your position trading.

The problem with retail traders is greed. Greed then leads to fear. Finally, fear leads to losing the trading account.

It is no wonder statistics look so bad. Over ninety-percent of the retail traders lose their first deposit.

How many do you think will try again? Few ones, for sure.

Irony shows us that the worst thing that can happen to a newbie trader is to win. Yes, that’s not a joke. In fact, it has its roots deep in human nature.

When winning at first, traders let down any guard, if they had one. Next, will start losing. Finally, will add to a losing position even what they don’t have in the trading account. The outcome fits the ninety percent statistic, only with more substantial losses.

We’ll cover, among other:

  • what is a Forex trading pip?
  • what will a Forex lot size give you?
  • tips and tricks for better position trading
  • money management rules to improve position sizing in Forex

Above all, trading is not gambling, and we’re here to prove it.

Position Trading

Position Trading as Part of Risk Management

Before live trading, traders must study the parts of a trading account. Ever wondered why demo trading differs than live FX trading? Traders don’t care about the outcome, that’s why.

Frequently, traders do great on the demo. However, fail lamentably on live trading.

One of the biggest mistakes is the risk approach. Or, risk management.

Because in demo trading traders didn’t care, they might get lucky. Hence, they’ll use the same approach when live trading. Naturally, with terrible consequences.

A trading plan doesn’t involve only the trading strategy. Unfortunately, traders spend most of their times looking for the perfect trading setup.

Position Sizing in Forex

Which is not bad! Not at all! However, the focus shifts from managing the money in the trading account to technical configurations.

Or, without knowing how to manage the portfolio, any trading strategy pales. Therefore, traders should dedicate more time to integrate the trading strategy with the money management rules that make the account grow.

We can say that the Pareto principle applies here too. The famous eighty percent ratio goes to looking for the perfect trading setup. However, only the rest of the proper risk management.

But if you don’t know the position sizing in Forex trading, the strategy fails eventually. Imagine not knowing how much is 1 lot Forex and trading it on a $200 account!

Hence, the risk management strategy or approach must be part of the trading plan. They need to have a correlation that allows the trading growing.

However, the key to growing a trading account starts with understanding it. Here are its parts:

  • balance
  • equity
  • free margin

Interpreting the Balance – Key in Position Sizing in Forex

One of the trickiest elements of a trading account, the balance, misleads traders. It does so by the fact that it remains unchanged. That is unless a trade hits the stop loss. Or, take profit.

Or worse, unless the trader closes the trade manually. Why worse?

Manually closing a trade implies no strategy at all. No risk-reward ratios, no money management. No nothing.

Coming back to the balance, it influences the position trading. Because traders focus on the balance (especially when the equity is less than the balance), they tend to underestimate the account’s exposure. Hence, the position trading.

When the equity of a trading account falls well below the balance, the usual step is to adjust the trading position. That is, to improve the position sizing in Forex trading from that moment on. And, to cut losses.

Cutting losses means either closing an entire trading position. Or, using so-called conditional closing. More precisely, closing only parts of a position.

In doing that, the balance/equity ratio improves to healthy levels. And, the account suddenly stands more chances to survive the test of time.

The balance of a trading account appeals to human nature. As traders look for every excuse possible to ignore when things go wrong, they’ll focus on the balance rather than on the real size of a trading account.

And, the real size of it belongs to the equity.

Forex Position Size Calculator

 

Equity of a Trading Account – Key to Calculating the Pip Forex Strategy

The equity is the real deal. After opening a trade, the equity chances instantly.

Not only that it is THE element traders should focus on. Also, it gives the right position trading and position sizing in Forex markets.

The equity shows the real value of an account. Because it shows paper profit or loss, it isn’t real money unless traders close the position.

The moment traders do that, the balance of the trading account changes and the balance to equity ratio improves too.

From a psychological point of view, traders have a hard time coping with losses. However, they have an equally hard time dealing with success too.

Losses lead to overtrading. Next, overtrading leads to untenable position sizing in Forex. Finally, wrong position trading leads to losing the trading account.

So far, we explained the balance and the equity’s role in understanding a trading account. Moreover, we established that they are essential in money management and position trading.

How about the free margin? What is that?

When opening a trade, the brokerage house blocks a sum as collateral. It varies from one currency pair to another. But, the broker does release it when the trade reaches the take profit or stop loss level. Or, when the trader closes the position earlier.

The free margin level shows the potential of the trading account. That is, what is the maximum position one can take.

Because traders are subject to human nature flaws, we tend to lose patience early. By losing it, we lose focus, and without attention, the trading plans fail.

Therefore, the first thing when the market goes against our belief (bullish something, or bearish another thing), we tend to overdramatize. Hence, we overtrade. Or, increase the position sizing in Forex trading.

How to Determine the Proper Position Sizing in Forex

The problem (because there is one) starts with the expectations. Traders come to the Forex market to win. Or, to make a profit.

However, the approach is wrong. Like it or not, the focus should differ.

How about starting with not to lose? Let’s focus first on how NOT to lose. Next, on how to win.

A simple change in approach leads to stunning results. First, the focus shifts.

Traders became proactive instead of complacent. Careful instead of greedy. Calculated instead of reckless. And so, the account grows. Or, the journey to master money management begins.

Risk Only a Percentage of the Trading Account

This is the best advice ever. No kidding!

However, as logic and straightforward the approach is, few can handle the pressure. What pressure, you say, as it should be none!

Well, how about the pressure of doing something? Only because the Forex market is open Mo-Fr, traders feel the need to do something. How about sticking to the original trading plan? Doing nothing is part of the plan, so let’s focus on following it?

Easier said than done. But a simple approach of risking a certain percent of the trading account brings unparalleled discipline. Moreover, you don’t need a Forex position size calculator or a Forex lot calculator anymore. Anyone can do it following the percentage rule.

What rule do you say? One or two percent on every trade, that’s the maximum risk allowed.

Even two percent is kind of aggressive, due to the highly unpredictable nature of Forex trading.

Hence, focusing on the one percent risk will end up with surprising results. How come?

Let’s run some math, so the benefit of disciplined position trading becomes visible.

Simple arithmetic shows that after seventy-two (72!) consecutive losing trades, the outcome is not that bad. There’s still fifty percent of the initial deposit left in the trading account.

Again, a simple rule like this, changes everything. Think of it!

As a newbie trader, chances or the stars aren’t aligned with your success. Almost certainly, you’ll fail.

However, even as a newbie, following the one percent rule, you’ll still end up having half of the initial deposit after such a terrible losing streak.

But then the next question is: how on earth to lose seventy-two consecutive trades in a row? Even the most passionate trader will question the trading style. The need for trading education becomes apparent.

Understanding the Position Size Calculator Approach

As always, we don’t want to leave things unclear. Or, better leave no stone unturned and no question not answered before ending the article.

Position Size Calculator

While it is easy to set a percentage as a stop on a trade, how about the trading size? Did we cover the lot size calculator issues so far or not? Well, not. But here it comes.

A proper lot size calculator Forex traders use focuses not on a correlation. That is, on correlating the percentage to risk (one percent) and the actual distance needed for the stop loss.

The result, you guessed, is the Forex lot size for the trade. Or, the right position trading.

Let’s consider the Elliott Waves Theory. Or, any other trading theory or technical analysis tool you fancy.

No matter what, a trade needs a stop loss. And, a take profit. But because we established earlier that the focus should be on how to AVOID losing, any analysis starts with the stop loss. Or, the risk.

According to Elliott clear invalidation levels exist in any scenario. Hence, there is a distance we can calculate. In pips.

However, after knowing the number of pips needed for the stop-loss order, another problem arises. How to integrate the stop loss with the percentage rule established earlier?

Lot Size Calculator

This is the key to position trading, so pay attention. First, find out the number of pips needed for the stop loss order.

Second, calculate the one percent size from the balance (!) of the trading account. Third, translate the number of pips into the $ amount of the trading account. Finally, you have the perfect position sizing in Forex, much needed to comply the one percent money management rule.

Practical Example Explaining the Position Trading

The EURUSD Forex pair is the most popular one among retail traders. And, not only.

Hence, we should use it to demonstrate how to calculate the right position sizing in Forex trading.

For 0.1 lots traded on the EURUSD pair, the value of a pip resembles one dollar. That is, assuming the trading account has USD and not some other currency.

Now let’s assume a trading account of 5k. Or, $5000.

And, using the same Elliott Wave principle, we need a stop loss that would invalidate our scenario of 238 pips. Sounds much?

In real pips terms, yes. In money management terms, there’s no difference! Position trading helps us integrate any stop-loss needed to the one percent rule.

Hence, the focus shifts to how to integrate the risk (238 pips) into the one percent rule. First, we need to calculate what one percent means from the balance of the trading account.

Quick math gives us $50. Therefore, if the price of a currency pair we trade travels 238 pips against the initial entry, we won’t risk more than $50. Understood?

Second, if 0.1 lots are one dollar/pip, that will give a maneuvering space of only fifty pips. However, the risk management approach requires two hundred and thirty-eight pips. No more, no less!

Or, 4.76 less volume (lots) for the trade. More precisely, 0.021 (0.02 is the most you can get on a micro-lots trading account). The right position trading revealed!

Risk-Reward Ratios to Complement the Trade

So far, the focus was solely on the risk. Or, what to lose, if we’re to lose.

Remember again: the efforts are on how NOT to lose before focusing on how to/much to win.

Still, the winning ratio is very important. The so-called risk-reward ratio is a valuable money management tool in tight correlation with position sizing in Forex.

While the right position trading defines the risk, the ratio represents the reward. According to our article here, the proper risk should be one percent of the balance of the trading account. How about the award?

The ratio shouldn’t be less than 1:2. Or, one percent risked, minimum two targeted. Ideally, three or more, but beyond three percent and we lose the sense of reality in Forex trading.

Not that is not possible to target higher risk-reward ratios. Everything is possible in Forex trading! But, probabilities or chances for such ratios to come true are so slim, we should discard them from the start.

What’s important is that the risk lead to the reward. And, the reward points to the account having even more chances to survive the losing streak mentioned earlier.

Only one trade that reaches the 1:2 or 1:3 target, increases the number of losing trades needed to wipe out half of the amount in the trading account!

Conclusion

Position trading and position sizing in Forex trading are crucial to success. Moreover, they are part of a proper money management system.

Such a system should not focus on how much a trader will win. No!

Instead, the focus shifts on how much the trading account stands to lose. And, how to avoid a losing streak by using proper risk-reward ratio.

With that in mind, traders have a better chance to avoid that terrible ninety percent loss rate statistic mentioned at the start of this article. Moreover, traders avoid the emotional rollercoaster trading is.

Consider the 238 pips stop-loss example. What can go wrong if the market goes one hundred pips against the original entry?

Or, say, two hundred? Or even if the stop loss order gets hit?

Nothing! Because the one percent is part of the trading plan, the money management system is sound and clear.

Not only that it increases the chances of surviving the market swings, but it gives the right position trading and position sizing in Forex.

Moreover, knowing the balance/equity appropriate ratio helps in understanding the risks when managing a trading account. After all, this is the aim, right? How to handle a trading account, even though retail traders lack the traits of a money manager! At least, that is true when they start trading.

All in all, yet another article about the importance of money and risk management. How many articles will still come to emphasize the importance of it? Probable many more!

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Damyan Diamandiev
Damyan Diamandiev

Damyan is a fresh MSc International Management from the International University of Monaco. During his bachelor and master programs, Damyan has been working in the area of financial markets as a Market Analyst and Forex Writer. He is the author of thousands of educational and analytical articles for traders. When being in bachelor school, he represented his university in the National Forex Trading Competition for students in Bulgaria and got the first place among 500 other traders. He was awarded a cup and a certificate at an official ceremony in his university.

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