For day traders and huge investors alike, the process of determining a position size during trading is of major concern. While trading, it is crucial to set a predetermined amount of a commodity or stock that is to be accumulated. However, since this is trading with forex, day traders will determine how much of the currency one has to accumulate. The size of one’s position, which is also known as trade size, determines the amount of risk.
The process of position sizing involves the number of units that one invests in a particular trade. The size of the position can be calculated using the concept of lots. Therefore, when a trader invests a certain number of a particular lot, be it standard, micro or mini, it is said to be the position size. In case the trade size or position size is small, there is a minimal risk that one is taking. On the other hand, it is the opposite when the position size increases.
Two factors affect position sizing. The first is trade risk, while the other is account risk. Trade risk refers to the challenge that one has to place an appropriate stop-loss order. Essentially, the stop-loss order is a set limit to the losses that one incurs while trading. Therefore, once the stop-loss is reached, trading activity is terminated. Account risk has to be considered when one is assessing the capital with which they are carrying out forex trading. The higher the capital invested, the higher is the profit or loss margin. Thus, if one considers why forex trading requires a strategy, the answer would be to mitigate these risks.
Given how the risks in trading relate to position sizing, it becomes clear that determining the right position size is a critical task. However, doing so is no easy task. Traders, in general, look to address the risks through the following steps:
To negate the effects of account risk, one has to set a risk limit. The most common way to do so is to set a risk limit to 1% of the capital invested. Therefore, in case the capital was $1000, the risk limit would be $10. Therefore, one would be willing to risk a loss of 10 dollars while trading.
The pip value represents a chance in the price of currency during a trade. The pip risk should be calculated by subtracting the currency price at the entry point from the point at which the stop-loss order is placed. For example, consider EUR/CAD. The buying price is at $1.4555, whereas the stop-loss is set at $1.4550. The pip risk in this trade consists of 5 pips.
Now that the pip risk has been determined, one has to calculate the pip value. To calculate the pip value, multiply the exchange rate of the first currency in the pair with the pip values attached to the lot type. A mini lot GBP/CAD pip value involves multiplying the value of the mini lot ($1CAD) by the exchange rate.
Finally, one has all the information required to find the ideal trade size. The formula to find it involves the multiplication of the number of pips at risk into the pip value and the number of lots traded. This will give an idea of how much is at risk. By adopting the strategies mentioned above, one can drastically reduce the risks accompanying the web of forex trading. Therefore, an individual should look to attain a sizable profit after creating the ideal position size.