One of the key elements in risk management in Forex is position sizing. It’s a decision you have to make with every trade, and it’s best if it’s consistent. While many traders believe that the most important element of trading is having a good method and applying it, position sizing can be just as critical in determining your success or failure. We’ll start by looking at the simplest scenario, which is placing trades that you don’t scale up on.
There are many ways to complicate position sizing, but there’s no reason to do so. When you put together your trading plan, you need to figure out how much you’re willing to risk on each trade. When you figure this out, note that you’re considering how much money you can lose if a trade goes against you, not how much you can win if you succeed. Always base your position sizing off of worst case scenarios – losing 100% of your investments. New traders regularly make the mistake of risking way too much money on their trades. It is unwise to risk 10-20% or more on a trade, no matter how confident you are. Successful long-term professional FX traders usually risk no more than 2.5% on their trades. Consider 5% an absolute maximum. 2% isn’t a bad amount to risk, either.
Depending on the way your trading platform is structured, you may need to calculate your risk in a particular way each trade. The factors you take into account should include how much money you have in your total trading bankroll, the percentage you’ve chosen, and the distance between your entry and your stop loss. The pip value is a key element too. You can mathematically calculate your position size as follows:
Multiply the amount of money in your bankroll by your risk percentage and then divide that by the number of pips you’re risking (that’s the distance between the entry and stop loss). Then divide that number by the pip value per standard lot. Check whether your platform can do all this for you. Many trading platforms will do the math for you. With Oanda for example, you can choose your stop loss and the amount of money you want to risk, and it will put up the proper position size for you. Alternatively, you can use a free online position size calculator to help manage your positions precisely. Oanda was also used because it offers flexible lot sizes, which is an absolute must if you have a small account. You can’t do standard lot sizes if you only have $1,000 in your trading account. That’d be way too big a percentage for you to risk. Such brokers like Oanda, AGEA and MahiFX let you wager as much or little as you want, even if it’s just a handful of dollars.
Scaling up, also called averaging up or pyramiding, is another topic that should be discussed. This is where you increase your position size if you’re winning on a trade. There are different practices for doing this; you should test any scaling up method thoroughly before you use it live since it can complicate your risk exposure. The benefits of scaling up are pretty clear; if your position continues to move in the right direction, you can become more profitable. The hardest part of making a good trade is often the beginning, and if you find that you’re in a trend, you may as well try to ride out the trend and get as much as you can out of it.
The drawback of scaling up is that if a position goes against you, it doesn’t need to go clear back to your entry to put you at break even anymore. If you doubled your investment and the price retraces 50%, you’re suddenly at break even, even though you’re not back to your entry. If price does go back to your entry level, you’re suddenly at a loss. If you don’t double your investment but choose some other amount, you have to carefully calculate the rate at which you’ll be losing money should the position reverse. So this is as much a trading style issue as it is an objective one. Some traders find this all too complicated and do better if they stick with a simple position sizing tactic. Others excel with scaling and go on to higher profits.
Setting a Target Profit
While we’ve focused largely on where you set your stop loss to determine your risk, it’s worth pointing out that another way you can ride out your winning trades without scaling is by moving your target profit and your stop loss after the trade is going in your favor. One thing traders will sometimes do is enjoy the benefits of a risk-free trade. A trade becomes risk-free when it goes in your favor and you move your stop loss to break even and push your target profit further out. If the trade continues to go in your favor, you can move the stop loss and target profit again. This locks in a small win, and gives you a chance at a bigger one. If you find out you’ve caught a trend, you can do this indefinitely, chasing larger and larger profits with no additional risk.
Why wouldn’t you do this? Depending on your strategy, it could result in a lot of break-even trades. It’s a more reliable and simpler method of riding out trades than scaling is for many traders though, and just one more idea to consider in regards to position sizing. Everything starts with making sure you don’t risk more than a tiny percentage of your account, but where you take your trades from there doesn’t necessarily need to be limited by your initial stop loss and target profit.