Determining the size of your Forex positions should be part of your risk management strategy. Position size directly impacts the value of the position which can be controlled by the number of lots a trader invests in a currency pair. Before entering a trade, you should have a plan which determines the size of your position based on several criteria which include:
- Account size
- Risk tolerance
- Financial goals
The size of the position that you take on each trade will directly impact your risk. This is just as important as deciding on your entry and exit levels. There are several strategies that you can use to determine the appropriate position to take, which is based on the way you plan to look at risk and reward ratio. This includes strategies such as fixed percentage, fixed dollar amount, or a variable-based strategy.
The first step you should take in determining your position size is to decide on the size of your account. The capital at risk should be discretionary funds. The most efficient way to allocate capital is by strategy. The reason is that a day trading strategy and a buy-and-hold strategy might have different risk/reward criteria. Even if all your capital is in one account, determining how much you plan to risk on a given strategy could be helpful and improve your chances of future success. Once you have determined how much capital you plan to risk on a given strategy you can then determine the risk you plan to take and the reward you hope to achieve. Your position size can be determined based on the risk and reward per trade. Your risk management strategy, which includes your position sizing, should be geared to your risk tolerance and your financial goals.
Calculating Your Position Size
Typically, you should keep the position size to no more than 5% of the capital in your account with the average trade size near 2%. A 2% trade size on a $10,000 would place your average trade size at $200. The next step is to determine how much you believe you need to risk on each trade. This could be a fixed dollar figure, a fixed percentage, or a variable percent/dollar figure. If you decide on a variable dollar or percentage strategy, you should initially start as a fixed dollar or percentage figure to estimate your initial position size.
Fixed Dollar or Fixed Percentage Returns
Your position size will be a function of how much you plan to risk and make on each trade. If you have a fixed dollar figure, you will need to determine the percent gain you expect to make from the movement of the exchange rate.
When you place your trade, your goal will be to take profits when the trade reaches your target. If your strategy is to ride your winning trades further, you might consider a trailing stop loss. This is a strategy where you move your stop loss up (if you are long a currency pair) or down (if you are short a currency pair) when the exchange rate moves in your direction. When you reach your target you might re-evaluate your risk and reward and alter your position size based on your new criteria. Your initial trade should never become a losing trade, which means your risk/reward criteria should never give back your initial gains. For example, if you plan to accept a 1% loss, when you reach your target of a 2% rise in a currency pair, you should never risk more than a 2% loss. In this instance, you need to assume a specific goal each time you move your stop loss. You can then go back and recalculate the amount you are willing to risk and determine the reward you want to achieve. Then you can recalibrate your position size.
Bottom Line To determine your position size, you need to separate your risk into two categories, trade risk, and account risk. Once you have determined your account risk, you can then work out the risk you will take per trade. Generally, investors keep their average risk per trade at a level that is approximately 2% of the account size. You should calculate your position size by determining how much you plan to risk based on a fixed dollar, fixed percentage, or variable-rate strategy. If you plan to use a variable-rate strategy, your initial fixed dollar/percentage loss should be the variable that determines your initial position size.