There are lots of position sizing calculators on the web, so it is not hard to work out the size of your trades. I like to define position sizing from a more general point of view. The size of a position is how many lots you wish to place and what that means in currency terms. As an example, my broker offers micro, mini and standard accounts, a micro account means 1 contract lot is the equivalent of $1000, a mini is $10,000 and standard is $100,000. When you trade you buy or sell these lots. The Forex market is all about leverage, it is what allows you to make more money with very little upfront risk. As an example most brokers may offer a leverage ratio of 1:500 which simply means I must risk 0.2% of what ever lot I am trading. I am trading $10,000 I must put in my account $20 this enables me to trade $10,000 (a mini lot). This in effect is leveraging or burrowing liquidity.
The above information is very important when deciding how many lots to trade or as we know it position sizing. Let’s see how deciding on a position size actually works in theory. So the currency market moves in terms of pips, on a micro lot 1 pip = $0.10, on a mini lot $1 and on standard $10. On the average day the most liquid pair EUR/USD moves and average 130-190 pips in any direction so in effect you need at least 200 pips of cash to burn if you want to day trade. So you want to do some position sizing now? You have a $100 and your broker is offering you bonus deals and offering you $25 deposits, great spreads, you are feeling ready. What do you do?
If you have a standard account then ideally you should have had $10,000 as starting capital, so you should really be looking to do a micro trade. The reason is simple, if the market went against you and you that day and you had opened a mini lot position, you would have had $100 and the market can move 190 pips in a session = $190, you would have destroyed your entire trading account and you will be crying how terrible the Forex market is. Had you placed a micro lot on the other hand you would have lost only 19% of your trading account and still been able to hold an overnight position if you felt the market will do better tomorrow. In effect you are still in the fight and may well end up not loosing at all. That’s the first lesson when position sizing, always get the right lot size in relation to capital.
Some market moves are sure bets precisely because everyone knows the overall trend of a currency pair. Take for example the RBA rate cut in Australia a few months back that sent the Aussie Dollar in free fall. It fell 1200 pips in a matter of a week. In scenarios like this it may be wise to double your position size or even treble. If you had bought 1 micro lot then you would have made a profit on $120 on such a move, if you had bought 3 lots then you would have made $360 that week. You didn’t even break a sweat. In effect buy more lots if you are reasonably certain via several indicators that market will go in your favour.
These are the two most important lessons when doing correct position sizing. Happy trading guys and don’t forget to rate the article if you found it helpful.