Position sizing is a key concept in trading, and refers to the number of units of an instrument that you trade. Proper position sizing is crucial in managing risk, as it allows you to control your level of exposure to the market.
It’s one of — if not THE most essential skill in trading. Traders manage risk, so if you plan on becoming a trader, you should be able to calculate position sizing with your eyes shut.
Position sizing also has an impact on your potential profits — more units traded means more potential profit (or loss).
To calculate position sizing, you need a few key pieces of information to properly do the math:
- Account equity or balance
- The forex pair or instrument you are trading
- The percent of your account balance you’ll put at risk
- Stop-loss in pips/units
- Conversion currency pair exchange rates
Calculating Position Size in Forex
We’ll use a couple of scenarios to demonstrate how to calculate your position size — keeping in mind your account size and risk tolerance. Note that these calculations apply to forex trading. Position sizing will differ for other instruments, based on lot sizes and a few other factors.
Whether or not your account denomination is the same as the base or quote currency will affect your position size so be aware when doing the calculation.
Scenario 1: Your Account Denomination is the Same as the Counter Currency
Here are the assumptions:
- Your account denomination is in U.S. Dollars.
- Your account has a $5,000 balance.
- You trade EUR/USD (or any other pair where the USD is the counter currency).
- You are a swing trader willing to risk 200 pips per trade.
- You only want to risk 1% of your account per trade.
Let’s calculate your position size to stay within your risk parameters…
Using figures for account balance and the percentage amount you want to risk, we can calculate the dollar amount to risk:
$5,000 x 0.01 = $50
Next, we divide the risked amount by the stop-loss to find the value per pip.
$50 / 200 pips = $0.25 per pip
Finally, we multiply the value per pip by a known pip value ratio for EUR/USD. For this example, with 10K units (one mini-lot), each 1-pip move is valued at $1.
$0.25 per pip * [(10K units of EUR/USD)/($1 per pip)] = 2,500 units of EUR/USD
So, you should put on a trade with a position size of 2,500 units or less of EUR/USD to stay within your risk parameters.
Scenario 2: Your Account Denomination is the Same as the Base Currency
Here are the assumptions:
- Your account denomination is in euros.
- Your account has a €5,000 balance.
- You trade EUR/USD (or any other pair where the EUR is the base currency).
- The exchange rate for EUR/USD is currently €1 = $1.20.
- You are a swing trader willing to risk 200 pips per trade.
- You only want to risk 1% of your account per trade.
Let’s calculate your position size to stay within your risk parameters for the same trade example above…
€5,000 x 0.01 = €50
The difference here though is that we have to convert this figure to USD first since the value of the pair is calculated by the counter currency. According to our assumptions, the exchange rate is €1=$1.20.
To find the value in USD, we must invert the exchange rate for EUR/USD and multiply by the number of euros you want to risk.
($1.20 / €1) x €50 = €60
Next, divide your risk in USD by your stop-loss in pips.
€60 / 200 pips = $0.30 per 1-pip move
Now you have the pip value with a 200-pip stop to stay within your risk parameters.
Lastly, we multiply the value per pip move by the known unit-to-pip value ratio.
$0.30 per pip x [(10K units of EUR/USD)/($1 per pip)] = 3,000 units of EUR/USD
Thus, to risk €50 or less on a 200-pip stop-loss of EUR/USD, your position size should be no bigger than 3,000 units.
Next, we divide the risked amount by the stop-loss to find the value per pip.
$50 / 200 pips = $0.25 per pip
Finally, we multiply the value per pip by a known pip value ratio for EUR/USD. For this example, with 10K units (one mini-lot), each 1-pip move is valued at $1.
$0.25 per pip * [(10K units of EUR/USD)/($1 per pip)] = 2,500 units of EUR/USD
So, you should put on a trade with a position size of 2,500 units or less of EUR/USD to stay within your risk parameters.
Using the risk management formula to calculate position size for different forex pairs is a critical skill for any successful trader. Position sizing based on this formula involves assessing the total amount of capital at risk and tuning it to your risk preferences.
What other factors to consider when determining your position size in trading?
When you’re trading markets, understanding and managing your risk is essential. When determining your position size, one important factor is how much you can afford to lose. Trading small amounts with careful risk management will help keep your losses low and improve the chances of profiting over time. Additionally, it’s wise to base position sizes on a percentage of your starting capital as this allows you to scale up or down your trades if needed. Furthermore, you should factor in the effects of leverage when setting a position size which can greatly magnify risks, though can also provide returns far greater than what would have been possible without it. Ultimately, doing some research ahead of time and paying close attention to your risk parameters will help ensure that you make better-positioned trades in the market.
Disclaimer: All information provided here is intended solely for study purposes related to trading financial markets and does not serve in any way as a specific investment recommendation, business recommendation, investment opportunity, analysis, or similar general recommendation regarding the trading of investment instruments. The content, in its entirety or parts, is the sole opinion of SurgeTrader and is intended for educational purposes only. The historical results and/or track record does not imply that the same progress is replicable and does not guarantee profits or future profitable trading records or any promises whatsoever. Trading in financial markets is a high-risk activity and it is advised not to risk more than one can afford to lose.
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