POSITION SIZE

Position Size

The focus of this phase of our learnings is managing risk through position size, risk/reward ratio and risk control.

For us, managing risk was not high on our list of priorities when we started trading.

However, once we understood the significance of money management and how it can affect emotions in a trade, we realised that it is the difference between becoming a successful or profitable trader and just being another failed trader.

We learnt that position sizing is more critical than pips risked.

We measure risk and return as the amount of pound sterling (money) risked or pound sterling earned.

It should not be thought of as percentages or pips, because pips gained or lost only tells half the story.

The number of lots you trade will dramatically affect your money risked or earned.

For that reason, you should never measure returns as just pips or percentages.

It is why some traders have issues trading with a large stop loss. They are thinking of pips, not money risked.

We fell into that same trap. We assumed that wider stop losses would require us to take on more significant risks with our account and that smaller stopped losses would result in lower sterling losses.

This was a false assumption. We were wrong and a big reason why we spent time trying to understand the role that position sizing can play in forex trading success.

Position size is essentially the number of lots you are trading per trade and can be standard, mini or micro-lots.

Anyone actively trading the forex market needs to fully understand why it is crucial to trade from a position size perspective. And how powerful it can be in helping you manage your emotions.

Position Sizing And The Risk To Reward Ration

A critical factor in achieving consistent profitability in the forex market is your understanding of the importance of the risk to reward ratio and how it relates to position sizing.

If you risk £100 on a trade and your target is £200, then you receive double the amount you risked if you win. This is a risk to reward ratio of 1:2.

With a risk to reward of 1:2, you can lose on over 50% of your trades and still make money over time. You could lose 65% of your trades with the risk to reward of 1:2 and make money.

Over a series of 10 trades, if you win only 35% of them with the risk to reward of 1:2, you would profit £50 if you risked £100 per trade.

That is where the power of the risk to reward ratio comes into play.

When we started trading, we were convinced that we had to win a very high percentage of our trades to make money in the market.

In reality, the winning percentage is nearly irrelevant in determining whether or not you make money over the long term.

What is essential is that you are taking advantage of the risk to reward ratio.

For example, if you maintain returns of 3 times the amount you risk your risk to reward ratio is 1:3.

That effectively means you can lose 7 out of 10 trades and still make money.

If you risk £100, you will lose £700 on 10 trades, but you would make £900 off your 3 winning trades because your risk to reward was 1:3.

The profit would be £200 even though you lost 70% of the time.

It is challenging to win more than 50% of your trades in any market.

Most successful traders only win about 50% of the time, at best, over the long run.

However, they understand the power of the risk to reward ratio, so they are still able to be profitable.

Adjust Position Size To Maintain Desired Risk Amount

Once you have figured out your risk to reward ratio on the trade, you need to implement the proper position size to make sure you manage your predefined risk (pound sterling).

Not all setups are created equal. There is inherently some amount of discretion in any trading method.

Forex trading is more art than science. Conditions can be volatile or quiet, trending or consolidating, or any combination of the four.

As such, it may be in your interest to risk slightly more or less depending on the quality of the setup at hand. This is where screen time and experience come into play.

Whatever amount you decide on, you will need to make sure you adjust the position size to meet the desired stop loss level. That will ensure that you maintain your sterling risk.

Just keep in mind that risking too much on any one trade will very likely impact your psychological stability. It could cause you to spiral out of control and commit a whole host of emotionally charged trading mistakes.

A general rule of thumb is to risk less than 3% per trade if you don’t have much experience with your trading method.

As you grow in experience and screen time, you can risk more or less depending on whether you think conditions call for it.

In summary, before entering any trade, you need to know the exact sterling amount you want to risk and the reward you think you can make on the trade.

Once you have determined the sterling amount you want to risk, then you adjust your position size to meet this amount.

Note that the start point is to decide how much money you want to risk. How much money can you afford to lose if the trade goes against you?

You are in control. You determine what you would be comfortable in losing, and you are not having your losses dictated by the market.

Build Your Risk Management Plan Around Position Sizing And Risk To Reward Ratios

The bottom line is that you absolutely must have a well thought out and clearly defined risk management plan if you truly want to have a fighting chance at making money in the forex market.

There is no way around this fact. You can get lucky for a while and make money without managing your risk. However, any seasoned forex trader will tell you that luck will only run for so long. The habit of not managing your risk will always come back to bite you.

Risk management doesn’t need to be complicated to understand or difficult to implement.

Aim For Consistency In Risk Especially Early On In Your Trading Career

We learnt the hard way that cranking up the risk per trade after a few winning trades was a mistake.

Doubling or tripling your risk too soon is a huge mistake.

You need to gain experience and learn your trading strategy until you have mastered it.

Maintaining a consistent risk per trade is very important in this stage and while building your account up.

You could set goals for yourself, and when you achieve them, you can consider increasing your sterling risked. For example, you might say that you will double your sterling risk per trade once you have doubled your initial trading account deposit.

You have to decide what is best for you and what you’re most comfortable with.

Just ensure that you maintain a constant per trade risk until you hit certain milestones in your account. This will help keep your emotions in check and will teach you patience. It will also help keep your losses contained.

By the time you have doubled your account or tripled it, you will likely be ready to handle the increase in per trade risk.

Managing your trading capital is really about preserving it.

You want to protect your money for the obvious or confluent high probability price action setups. This way, you maximise your profit potential.

From experience, where most traders go wrong is that they abuse and overuse their trading capital. They quickly give back profits mostly because they don’t have the patience to stay out of the market and wait for another high-quality price action signal to form.

When you lose money in trading, you have less capital to work with. To make back what you lost, you have to earn a substantially higher percentage return than what you lost.

So keep your position sizes small initially and apply stop losses.

It is paramount that you protect your trading balance. You’re trading the forex market not gambling in the forex market.

If you lose 25% of the money in your account, you should stop trading live. Go back to demo trading until you trade profitably.

Risk Rewarded 

The winning percentage is irrelevant when you incorporate a robust risk to reward process in your trading.

If your trading approach generates profits that are larger than your losses, over time, your account should grow.

Maybe that is a bit of an exaggeration because you do need to win some of your trades. So the winning percentage is not ‘irrelevant’ but what we are saying is that it’s not very important. Certainly not as much as some traders think.

A skilled and experienced price action trader with a lot of patience to wait for only the most obvious setups (trading like a sniper) should easily be able to win at least 50% of his or her trades.

When you combine that with a strong risk to reward, you can quickly see how their profits would start adding up.

However, the key here is having patience.
There may only be a few good setups per month that lead to big moves… but that’s all you need.

Even if your account is small, worry about trading well. Don’t worry about taking a lot of trades each month.

Just remember that being a skilled and profitable trader is the goal… the goal is not making a lot of money right away.

The money will attract itself to you over time as you demonstrate consistent patience and discipline.

Position Size Formula 

You need to know four things:

Firstly your account size.

Then you have to decide what percentage of risk you want to take on the trade.

Then you need to know the pip value of the currency that you’re going to trade. They vary depending on the denomination of your account and the currency that you are trading.

(we use the Mataf website to identify the pip value)

Finally, you need to know the size of the stop that you intend using

Step 1

Multiply your account balance BY the % that you want to risk.

That gives you the sterling amount that you want to risk.

Step 2

Multiply the stop size (in pips) that you are going to use by the pip value of the currency you will be using.

This gives the sterling amount of the stop (stop value) you will be risking if you were using a standard account.

Step 3

Simply divide the amount you want to risk (step 1) by the risk for 1 standard lot (step 2).

That gives you the lot size/position size that you need to use.

The lot size/position size is the number that you enter as your “volume” on the order screen.