Your position size, also known as your trade size in units, is more significant than both your entry and exit locations when you are day trading foreign currency (FX) rates.
You could have the best forex strategy in the world, but if the position size of your trades is too large or too tiny, you will either expose yourself to an unacceptable level of risk or not enough risk at all. And putting too much of your money on the line will soon wipe out your trading account.
“DISCLAIMER: There is a very high level of risk involved in Forex Trading. With respect to margin-based forex trading, off-exchange derivatives, and cryptocurrencies, there exists considerable risk, including but not limited to, leverage, creditworthiness, limited regulatory protections, and market volatility that may substantially affect the price, or liquidity of a currency or related instrument. It should not be assumed that the methods, techniques or indicators presented in this product will benefit, or will not cause harm. Read more about the risks of forex trading.“
The number of lots, as well as the type and size of lots, that you buy or sell in a trade are the factors that determine the position size.
- One micro lot is equal to one thousand of a given currency’s units.
- A tiny lot is 10,000 units
- A typical lot consists of 100,000 units.
Trade risk and account risk are the two components that make up your total risk exposure. The following is an explanation of how all of these factors interact with one another to provide you with the appropriate position size, regardless of the market conditions, the trade structure, or the method that you are utilizing.
Set Your Account Risk Limit Per Trade
When it comes to determining the position size when trading forex, this is the most crucial phase. You should restrict the amount of money or percentage you are willing to lose on each trade. If you have a trading account with a balance of $10,000, for instance, and you use the 1% restriction, you may potentially lose $100 on each trade.
If you have a risk limit of 0.5%, then the most you can risk on any given trade is $50. Your monetary limit is always going to be based on the size of your account, in addition to the maximum % that you choose. This limit will serve as a reference for you in every transaction that you engage in.
The majority of skilled traders will risk no more than 1 percent of their total account.
There is also the option of using a predetermined monetary sum, which should likewise be less than or equal to 1% of the total value of your account. You might, for instance, put $75 on the line with each deal. As long as the total amount in your account is $7,500 or more, the amount of risk you face will be 1% or less.
Account risk should be maintained at the same level regardless of any changes to the other trade variables. It is not a good idea to risk 5% on one trade, 1% on the next trade, and then 3% on the next trade. Make a decision on the percentage or the dollar number that you will use, and stick with it, unless you reach a point where the dollar amount that you have chosen surpasses the limit of 1%.
Prepare for the Point-and-Pip Risk in a Trade.
Now that you are aware of the maximum amount of money that can be lost on each trade, you can focus your attention on the trade that is now being presented to you.
The difference between the position size at which you enter the trade and the point at which you set your stop-loss order is what determines the pip risk for each individual trade. Pips, which is an abbreviation that can mean either “percentage in point” or “price interest point,” are often the tiniest variable component of the price of a currency.
A pip, often known as one-hundredth of one percent, is the unit of measurement used for the majority of currency pairs. A “pip” is equal to 0.01, or one percentage point, for currency pairs that contain the Japanese yen (JPY). A few different brokers may choose to display the rates with an additional decimal place. A pipette is the name given to the fifth (or third, for the yen) place in the decimal system.
A trade is terminated according to the stop-loss order if it falls below a predetermined loss threshold. It is how you ensure that your loss will not be greater than the account risk loss, and the location of it is also determined by the pip risk for the deal. If you buy a EUR/USD pair at $1.2151 and place a stop-loss order at $1.2141, for instance, you are exposing yourself to a loss of 10 pips.
Pip risk might change depending on the volatility of the market or the trading method. There are occasions when one trade can have a risk of five pips, while another deal might have a risk of 15 pips.
When you enter a trade, you need to give thought to both your entry point and the location of your stop-loss order. You want the stop-loss order to be as close to your entry point as is practically possible, but you don’t want it to be so close that the trade is terminated before the move that you are anticipating.
After you have determined, in terms of pips, how far apart your entry point and your stop loss are from one another, the next step is to compute the value of a pip depending on the lot size.
Learn the Value of a Pip Before You Trade
If you are trading a currency pair in which the United States dollar is the second currency, also known as the quote currency, and your trading account is financed with dollars, then the pip values for different sizes of lots will always be the same. The point-in-figure value, or pip, for a micro lot is $0.10. It costs one dollar for a little lot. In addition, the price for a regular lot is ten dollars.
If the quote currency in the pair you are trading is not the U.S. dollar, then you will need to multiply the pip values by the exchange rate that applies to the dollar in comparison to the quote currency. If your trading account is financed in dollars, then this step is not necessary. Suppose you are trading the euro against the British pound (EUR/GBP) pair, and the price of the USD against the GBP pair is currently $1.2219.
If you were trading EUR/GBP with a micro lot, the pip value would be $0.12 ($0.10 times $1.2219).
It would cost $1.22 for a tiny lot ($1 multiplied by $1.2219).
It would come to a total of $12.22 for a normal lot ($10 multiplied by $1.2219).
Now, the only thing that has to be computed is the position size
Determine the Position Size in a Trade.
The following formula can be used to determine the ideal position size:
Pips at risk * pip value * lots traded = amount at risk
The position size is determined by the number of lots that are traded, as shown in the preceding calculation.
Let’s say you have an account of $10,000, and you risk one percent of that amount on each trade you make. Therefore, the most money you can put on the line in a single trade is $100. You decide to trade the EUR/USD currency pair, and you decide that the best price to purchase at is $1.3051, with a stop loss order set at $1.3041. This indicates that you are putting 10 pips ($1.3051 minus $1.3041 = $0.001) on the line. Due to the fact that you have been trading in small lots, each point of price change is worth $1.
If you enter those figures into the formula, you will obtain the following results:
10 lots sold at $1 each equals $100.
If you divide both sides of the equation by ten dollars, you will get the following results:
Lots traded are equal to 10
Because one standard lot is equivalent to ten mini lots, you have the option of purchasing either one standard lot or ten mini lots.
Now let’s look at a hypothetical situation in which you are trading micro lots of the EUR/GBP currency pair and you make the decision to purchase at $0.9804 and set a stop loss at $0.9794. This again constitutes a risk of 10 pip.
10 lots at $1.22 each multiplied together equals $100.
Keep in mind that the value of $1.22 was derived using the conversion procedure that was shown in section three above. This value would alter depending on the current exchange rate that exists between the United States dollar and the United Kingdom pound. When both sides of the equation are divided by $12.20, the following answers are found:
The number of lots traded = 8.19
Therefore, the appropriate position size for this trade would be eight mini lots and one micro lot on your part. You should feel confident in your ability to determine the lot position size on your forex trades if you keep this formula in mind and also keep the 1% rule in mind.
Questions That Are Typically Asked about Position Size (FAQs)
How do you hedge a position size while trading forex?
Forex traders can choose from a wide variety of hedging strategies. A hedge can be defined as any trade that you enter into with the expectation that it will move in the opposite direction of your present currency position.
The hedging trade may take the form of an additional forex position, such as selling the dollar against one currency pair and purchasing it against another currency pair. The hedging activity can alternatively take place in a different market, for as by using exchange-traded funds (ETFs) that track the dollar index or futures contracts.
In foreign exchange trading, what is meant by the term “open position”?
A deal that you are still involved in is referred to as an open position. For instance, if you initiate a transaction by exchanging dollars from the United States for yen from Japan, then that trade is deemed “open” until you exchange the yen for dollars again. Day traders frequently open and close positions throughout the course of a single trading day.