When trading foreign exchange (forex) currency exchange rates within a day, your position size, or trade size in units, is more important than your entry and exit points. You could have the best forex strategy in the world, but if your trade size is too large or too small, you will either take on too much risk or too little risk. Taking on a large risk can wipe out your trading account quickly.
Determine the maximum risk for your account on each trade
This is the most important step in determining position size in forex trading. Set a percentage or a specific amount of risk that you will take on each trade. For example, if you have a trading account of $10,000, you could risk $100 on each trade if you use a maximum percentage of 1%. If your maximum risk is 0.5%, you could risk $50 on each trade. Your maximum risk will always be determined by the size of your account and the maximum percentage you set. This limit becomes your guideline for every trade you make.
Plan for point risk on each trade
Now that you know the maximum risk for your account on each trade, you can focus on the trade in front of you.
The point risk on each trade is determined by the difference between your entry point and your stop-loss order point. A point, which means “a percentage in point” or “point of profit in price”, is usually the smallest part of a currency’s price that changes. For most currency pairs, the point is 0.0001, or one hundredth of a percent. For pairs that include the Japanese yen (JPY), the point is 0.01 or one percent point. Some brokers choose to quote prices with ten additional decimal places. The fifth decimal place (or the third for yen) is called a “pipette”.
Understand the point value for the trade
If you are trading a currency pair where the US dollar is the second currency, and your trading account is funded in dollars, the point values for different contract sizes are fixed. For a micro lot, the point value is $0.10. For a mini lot, it is $1. And for a standard lot, it is $10.
If your trading account is funded in dollars and the quoted currency in the pair you are trading is not the US dollar, you will need to multiply the point values by the exchange rate of the dollar against the quoted currency. Let’s assume you are trading the euro/pound sterling (EUR/GBP) pair, and the US dollar/pound sterling (USD/GBP) pair is trading at $1.2219.
For a micro lot of the euro/pound sterling pair, the point value would be $0.12 ($0.10 * $1.2219), for a mini lot it would be $1.22 ($1 * $1.2219), and for a standard lot, it would be $12.22 ($10 * $1.2219).
Determine the position size for the trade
The ideal position size can be calculated using the following formula:
Points at risk * Point value * Number of contracts traded = Amount at risk
In the formula above, the position size is the number of contracts traded.
Let’s assume you have an account of $10,000 and you are risking 1% of your account on each trade. Thus, the maximum risk amount is $100 per trade. You are trading the euro/US dollar pair, and you decide to buy at $1.3051 and put a stop loss at $1.3041. This means you are risking 10 points ($1.3051 – $1.3041 = $0.001). Since you are trading mini lots, each point movement has a value of $1.
If you input those numbers into the formula, you will get:
10 * 1 * Number of contracts traded = $100
If
Dividing both sides of the equation by 10, you will arrive at:
Number of contracts traded = 10
Since 10 mini contracts equal one standard contract, you can either buy 10 mini contracts or one standard contract.
Now let’s take another example where mini contracts of the Euro/British Pound pair are traded, and you decide to buy at $0.9804 and place a stop loss at $0.9794. This also means a risk of 10 pips.
10 * 1.22 * Number of contracts traded = $100
Remember that the value 1.22 comes from the conversion formula above in section three. This value may vary depending on the current USD to GBP exchange rate. If you divide both sides of the equation by 12.20, you will arrive at:
Number of contracts traded = 8.19
So your position size for this trade should be eight mini contracts and one micro contract. Using this formula with the 1% risk rule, you are well-equipped to calculate the contract size and position in your forex trades.
Frequently Asked Questions (FAQs)
How can you hedge a forex position?
Traders have several options for hedging a forex position. Any trade you expect to move in the opposite direction of the current forex position can be used as a hedge. The hedging trade can be another forex trade, like selling dollars in one pair and buying them in another. Hedging can also occur in another market, such as through dollar index ETFs or futures contracts.
What is an open position in forex trading?
An open position is simply a trade that you are still in. For example, if you initiated a trade selling the US dollar against the Japanese yen, that trade is considered “open” until you trade the yen against the dollar again. Day traders can open and close positions multiple times within just a few hours.
Source: https://www.thebalancemoney.com/how-to-determine-proper-position-size-when-forex-trading-1031023
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