Even the best entry point may result in losses, a margin call and a stop out (which we have covered in our previous articles) unless… Unless you calculate the position size correctly.
Without having relevant skills and ability to calculate the right lot per trade, you won’t be able to make profit in the financial markets. In today's review, we are going to get to the bottom of this topic and discuss the maximum and minimum size of the trading position.
1. Position Size: What Is It and Why Is It So Important
2. Procedure for Calculation of the Open Foreign Currency Position Size
3. How to Calculate Position Size
4. Risk and Money Management: Here’s What Should Be Factored in
Position size is essentially the amount of money you open the trade with. The more you buy, the higher the profit you make with the price fluctuations per pip when the price quotes are going up. With that said, your risks increase as well when the price suddenly goes against you! This is why it is essential to know how to calculate the position size accurately.
What does the lot size you enter the trade with depend on? Basically, it depends on the following aspect:
Let's examine this using the example of the foreign currency pair. You already know that the forex position size is determined by the number of lots. In terms of major currency pairs, the lot is typically 10 or 15 units of the base currency (the one that is listed first in the currency pair). Nowadays brokerage companies allow to trade fractional pips. This is why the size of the foreign currency position is the lot volume you’ll be opening a position with.
One of the first steps you need to take is determine the entry point. Based on the rules of the trading strategy, you will need to identify the entry price, the level of the stop loss and take profit.
Suppose you’ve decided to sell a GBP/USD pair when the price bounces off the resistance level of the descending channel. The profit potential per trade is 150 pips. Stop loss according to market demand is 45 pips.
1. Based on the expected value of your trading strategy, determine the risk percentage per trade. More often than not, it is about 1–2 % of the amount available in your trading account.
2. If you have $10,000 in your account, calculate the size of risk expressed in monetary terms (х) using a simple formula shown below:
In other words, the amount of money you can lose in this trade cannot exceed $100.
3. What you should do next is calculate the position size given the price of one pip. It will be 10 U.S. dollars for the whole lot in GBP/USD pair.
4. Stop loss per trade is 45 pips. This means that it will be $450 in monetary terms for the whole lot.
5. The allowed risk is $100, so it’s clear that the lot will be fractional. Let’s calculate its size (х) using the formula below:
Now you know how to determine the size of the open currency position. This parameter is one of the essential elements of the risk and money management systems. If you’re only starting your stock market journey and don’t have your own money management system yet, here’s a list of the things you need to be able to determine:
1. Size of the stop loss order (depends on the trading strategy).
2. Maximum allowed risk per trade.
3. Position size based on the two list items mentioned above.
Calculations of the position size don’t have to be made manually every single time. There is a way to speed up this process by using a Position Size Calculator that does it all for you automatically.
In addition, in order to avoid the margin call and stop out, you need to know how many open trades you can have simultaneously given the size of your trading account and trading strategy.
Learn about setting the limits for open foreign currency positions and what position size to risk percentage is. Decide how and where you wish to make calculations. These can be Excel tables or Online Calculator. It’s totally up to you.
The time you dedicate to mastering money management and developing a risk management strategy will certainly pay off while knowledge gaps will sooner or later lead to losses.