Forex position sizing refers to the process of determining the appropriate amount of lots to buy or sell in a particular trade based on the available trading capital, risk tolerance, and market conditions. Position sizing helps traders control their exposure to potential losses and maximize their profit potential.
Proper position sizing can help traders avoid overtrading, reduce the risk of losing a significant portion of their account, and increase the likelihood of long-term profitability. Deciding your position sizing strategy should be done before you start the trading day or week to avoid making poor decisions based on short term results.
To determine the correct position size for your account follow the below steps:
Step one: Determine your trading capital
Trading capital refers to the amount of money that a trader has available to invest in the foreign exchange market. Some traders use their account balance as their trading capital but you do not need to transfer all your trading capital to a broker.
Step two: Determine risk per trade
Normally traders will risk 1 to 2% of their capital per trade. For example, if a trader has an account balance of $10,000 and wants to risk 1% of the account on a trade, they would only risk $100 on that trade.
Step three: Determine market stop
Depending on your trading strategy the number of pips stop required will change. For example a day trader might use a 5 pip stop whereas a swing trader might use a 50 pip stop.
Step four: Determine position size
Using the value of 1 pip for 1 lot you can work out the correct position size. For instance if 1 pip equals $10, a day trader could trade a 2 lot position ($100 / (5 pips * $10)) whereas a swing trader could trade a 0.2 lot position.
When to increase position size
As you make profits your account balance will grow so naturally you can trade a larger position. While it is dangerous to change from 1% to 2% position size during the trading day each week it can be beneficial to review your percentage risk per trade. If your strategy is performing well, increasing your risk per trade at the start of the week to 2% could help you maximize profits.
Many traders find it difficult to increase their trading position as they feel added pressure with larger profit and loss swings. It takes practice to focus on your profitability in pips rather than watching your account balance. If you are struggling to follow your trading plan when you increase position size it is best to reduce your position size back to your usual level. While it can be difficult to remain calm when trading a bigger position size it is vital if you are going to reach your trading goals.
When not to increase position size
The worst time to increase your position size is after a loss. It can be very tempting to double your position size after a loss as it can be a quick way to recover your losses. In the short term you might be able to achieve better results by increasing your position size but should you continue to make losses it is possible your account value could go to zero. After a loss it is best to take a short break and analyze what caused the loss and then trade again with the same position size or smaller.
When to decrease position size
The ability to minimize losses is a vital skill traders need to master. The percentage risk per trade method will naturally reduce your position over time as you make losses but this might be too slow. If you lose confidence in your strategy it is best to quickly reduce the risk per trade to 0.50% or lower to prevent further losses. Take time to review your strategy and find ways to improve your trading process. Once your strategy is showing consistent profits again you can increase your position size.
When not to decrease position size
If your trading strategy is performing well you need to maximise your profits. Some traders get scared when making profits as they believe their luck may run out. Trading is not about luck if your strategy is performing well in the current market look to increase your position size rather than decrease.
Position sizing is an often neglected part of trading for many traders. Using a consistent and well thought approach to deciding your position size is vital to your long term success as a trader.