In forex trading, new traders can get so caught up in finding the right entry and exit signals before they ever trade. They look for a “holy grail” indicator or the perfect chart setup that will allow them to make money. The truth is, what long-term trading success has very little to do with market forecasting and a lot to do with risk control.
Welcome to forex position sizing. Position sizing is the single most important skill that distinguishes the professional traders from the amateur traders. Traders aren’t evaluated by the amount that they win when they’re right; they’re rated by the small amount that they lose when they’re wrong.Forex position sizing is about keeping your trades smart, preserving your capital; and staying in the game long enough to earn a profit.
This guide will go over how to eliminate the confusion and illustrate a simple step-by-step method of calculating the exact position size for every chosen trade..
Why Forex Position Sizing is Your Most Important Skill
Before we talk about the how, it is important to first understand the why. Setting your position size appropriately in forex is the foundation of any robust trading plan for a number of compelling reasons:
- It Protects Your Capital: The number one rule to trading is to protect your capital. Without capital, you can not trade. When you position size correctly, it means that the loss of one trade or even several in a row, will not cause your account to be depleted.
- It Removes Emotion: By taking the guess work and emotion out of your risk decision-making through a math-based formula, you will not enter a trade out of greed nor will you the opposite and follow through with a tiny trade out of fear. Your risk per trade forex is predetermined and rational.
- It Enables Consistency: Professional trading is about processes and consistency. When you apply the same rules of risk management to every trade, you create a consistent process whereby you are consistently building your account over a period of time.
Moreover, disciplined forex position sizing allows you to be in control in an uncertain environment.
The Key Ingredients for Correct Lot Size Calculation
To determine your perfect position size, you only need to quantify four key items. Consider them as components in your risk management recipe.
- Account size: You will need the total amount of cash in your trading account (ie. $10,000).
- Risk %: The maximum percentage of your account you are willing to risk on one trade. Professionals typically recommend 1-2%. This will determine your risk per trade forex.
- Stop Loss in Pips: The number of pips from your entry price to your stop-loss price. This should be determined based on your technical analysis (e.g. below a support level); not a random value.
- Pip Value: The monetary value of one pip for the currency pair you are trading.
With the above four variables, you have all you need to make an accurate lot size calculation.
A Step-by-Step Guide to Forex Position Sizing
Let’s walk through the calculation with a clear example.
Scenario:
- Account Size: $10,000
- Risk Percentage: 1%
- Currency Pair: EUR/USD
- Stop Loss: 50 pips
Step 1: Determine Your Risk in Dollars
First, calculate the maximum amount of money you’re willing to lose on this trade.
- Formula: Account Size x Risk Percentage = Risk in Dollars
- Example: $10,000 x 0.01 = $100
This means your maximum acceptable risk per trade forex is $100.
Step 2: Calculate Your Position Size
Now, use your risk in dollars and your stop loss in pips to determine the correct position size. The standard formula involves the pip value, but an even simpler way is:
- Formula: (Risk in Dollars / Stop Loss in Pips) = Value Per Pip
- Example: $100 / 50 pips = $2 per pip
You’ve now determined you need a position size in which each pip movement is worth $2. EUR/USD is $10 for a standard lot ($100,000), $1 for a mini lot ($10,000). Therefore, you want to trade 0.2 mini lots (or 2 micro lots) to achieve a pip value of $2. That’s the calculation for lot size.
Step 3: Use a Position Size Calculator for Simplicity
Manual calculation of lot size is a useful skill, but may take time. Fortunately, technology makes this task easy. The position size calculator is a trader’s best friend.
A position size calculator does all the calculations for you. All you have to do is input your account size, risk, stop loss in pips, and currency pair. It calculates the correct lot size for you in a matter of seconds. Most reputable brokers provide their clients with an all-in-one personal position size calculator on the price chart. If you choose these brokers, an integrated position size calculator on your account screen automatically does everything for you. Brokers with user-friendly back-end systems such as Capitalix and SmartSTP provide their clients many tools for guiding their risk management, such as a personal position size calculator on their price chart. Other brokers such as FX Road, Trade EU Global, and CapPlace provide their clients with tools for risk management, since these brokers greatly prioritize the user experience of their clients. Brokers such as FirstECN, SuxxessFx, Tradgrip, and Algobi want their clients to become empowered traders, and a consumer-friendly position size calculator is often a large component of that goal.
Don’t Forget the Forex Risk Reward Ratio
Proper forex position sizing determines how much you can afford to lose. The other part of the equation is the forex risk reward ratio; this measures how much you could win in relation to how much you could be risking. The forex risk-reward ratio compares the potential profit of a trade (the distance from your “entry” to your “take-profit”) compared to how much you could potentially lose (the distance from your entry to your “stop-loss”). For example:
- Risk = 50 pips (stop loss)
- Reward = 100 pips (take-profit)
- This gives you a forex risk reward ratio of 1:2.
It is important to stick to trades with a positive (ideally 1:2+) forex risk reward ratio. This means that even if you are winning 50% of your trades you will still be profitable in the long run.
Conclusion
Don’t guess your lot sizes. Don’t risk too much on one trade and too little on another. Discipline is key to becoming an expert trader and proper forex position sizing is at the heart of that discipline.
Just as you can learn the parts, follow the basic steps of lot size calculation, and use a position size calculator, you can control your risk. When you master this task, you will trade like a professional with confidence and consistency.
FAQs
- What exactly is forex position sizing?
Forex position sizing is the process of determining the appropriate number of currency units (lots) to trade based on your account size and risk tolerance. It’s a risk management technique designed to keep losses at an acceptable level.
- Why is defining the risk per trade forex so important?
Defining your risk per trade forex (e.g., 1% of your account) is crucial because it prevents a single bad trade from causing significant damage to your capital. It ensures consistency and protects you from emotional decisions, which is vital for long-term survival in the markets.
- How does a position size calculator work?
A position size calculator is a simple tool that automates the lot size calculation. You input your account currency, account balance, risk percentage, stop-loss in pips, and the currency pair, and it instantly calculates the exact position size you should use to adhere to your risk limit.
- What is a good forex risk reward ratio?
While it depends on the trading strategy, a commonly recommended minimum forex risk reward ratio is 1:2. This means for every dollar you risk, you aim to make two dollars. This allows you to be profitable even if you win less than half of your trades.
- Can I be profitable if I lose more trades than I win?
Yes, absolutely. This is possible if you maintain a positive forex risk reward ratio. For example, with a 1:3 risk/reward ratio, you only need to win one out of every four trades to break even. Winning just 30-40% of your trades would make you consistently profitable.