You know where to enter and where to exit by placing stop loss. Now it is time to see how to set the position size. How would you determine the current amount of units you would want to buy or sell in your trade? Due to high leverage, setting the wrong lot size can be really devastating at times. Don’t worry, we have this article for you. Position sizing is another important skill to be learnt by the Forex traders. As we always say, you need to understand the basics and then with experience you gain confidence. That said, let us get started straight away.
Before getting into the calculation part of it, let us see what and all you need handy before you get started. First of all the basic factors are decided upon and are in place. This includes, the currency pair you wish to trade, the percentage of your account you want to risk currency conversion rates etc. Now determine where you are going to place your stop loss for a trade.
Your stop loss placement is an important factor in coming up with the decision on the lot size. You can decide it based on your percentage, chart indicators or market volatility whichever method works well for you. Ok so you have decided the number of pips after which you want to have your stop loss.
Next step is to determine the risk percentage. Calculate the total amount you would want to risk for your trade based on the risk percentage and total account balance.
Once you have the risk amount and the number of pips you are risking, it is easy for you to calculate the value of each pip. This number turns out to be the most important factor in determining the lot size. Have a look at the example below to get a clearer picture of what we are trying to say.
Example: After you select your entry point and you have also determined the place where you would want to place your stop. Suppose your account balance is $5,000 and you have decided that you are ready to risk 1% of your account which is $50. Your stop is say 25 pips away from the entry. To determine the value of a pip, you have to divide the risk amount by the number of pips you are risking. This means, value of each pip is $2. So, if we lose $2 for each pip, our total loss would be $50 which is 1% of our account balance. Or in other words you need to calculate your lot size according to the value per pip. A mini lot size causes you a loss of say $1 for each pip movement against you. So if you buy 2 mini lots, for one pip movement you would be losing $2. Thus your ideal position size could be 2 mini lots or 20k units of the currency.
Forex market is a place where you have high leverage and liquidity and thus even a smallest of an effort and capital can return high profit. While on one hand you can think of making huge profits on the other hand it indicates that the risk involved is high. So make sure you are ready to lose the amount you initially think of and then enter into the market with a cool head.
You should always take advantage of the largest position size available while ensuring you meet the risk % you set. Position sizing is an important factor for risk management. With everything else in place a wrong lot size can really hit you hard. And remember to adhere to trading disciplines. Don’t ever get into a panic mode while trading.