Position Sizing: Forex Profit Trading Secrets
Say you have chosen one of the forex brokers as intermediaries to conduct transactions on the international money market. You have made a deposit and prepared to look for opportunities from price movements. You have prepared a strategy that has been tested before so that you are sure of its accuracy. But before you go further, you should also have prepared a good capital management method, one of which is mastering “position sizing”.
Once there was a beginner trader (call it Jasmine) who experienced a tremendous loss because he opened a position with too many lots. At that time George thought that the bigger the lot she used, the greater the profit she would get. “Why must I trade with 1 lot if my capital is enough to open a position of 10 lots?” He thought.
True jasmine on one side: that the bigger the lot, the greater the profit multiplier. But George forgets that the losses will be equally great. This kind of mindset that makes many traders – especially beginners – end in destruction. At least that’s what I’ve noticed in my career as an analyst and educator at several forex brokers .
You certainly don’t want to experience a fate like Jasmine. Therefore you decide to read this article to completion.
What is ” Position Sizing “?
Simply put, ” position sizing ” is basically a way of managing capital in making transactions. When trading, you really have to take into account how many lots must be opened each time you make a transaction. If it’s too large, then the risk you face will be too large. Conversely if it is too small then it can mean “wasting” the potential that you have. In essence, you need to know the right amount of lot when opening a position.
Position sizing is closely related to risk management. In a simple context, you may already know that the risks in forex trading can be limited by setting loss limits. For example, with an initial capital of $ 10,000 you limit the risk by 50%, or equal to $ 5,000 (called risk capital ). Means, the loss you will incur (if it happens) will not exceed $ 5,000.
Well, this position sizing will make your risk capital more efficient.
Why Need Position Sizing ?
You need to understand first, that forex traders are basically ” risk managers “. You must be able to “regulate” the potential risks that exist.Position sizing is the most important skill in capital management and can help you stay in the “safe and comfortable” zone when trading.
So, before you really start trading with the money that you have collected with difficulty, you should first understand this one technique.Even if you can, you can do it outside your head.
How to use?
Position sizing is actually relatively easy to understand and run. Yes, it does involve a little math, but it is still at the basic level.
There is an example that hopefully can facilitate understanding. I will show you how to calculate the amount of lots that can be used based on capital and defined risk limits.
Let’s go back to George , who now understands position sizing.
George has a $ 10,000 amount on her trading account and has set a risk capital of $ 5,000. Because he did not want the previous experience to repeat itself, George had set a risk of 10% per transaction from risk capital. That means $ 500 / transaction.
After observing the market, George decided to trade in the EUR / USD pair. Based on the technical analysis, he saw that the risk limit was 200 pips (1 pip = $ 1). That means that technically the limit of Jasmine stop loss is $ 200.
The question: how many lots can George use to open a position?
Easy. Jasmine just divides the risk per transaction with the amount of stop loss that has been obtained based on the analysis. In this example, the risk per transaction is $ 500 and the stop loss limit is $ 200. Thus, the maximum lot amount that can be opened by George is: $500/$200 = 2.5 lot
Easy right ? With the number of lots, George will not experience losses that exceed the “comfort level” . He can also optimize the capital he has, but still in a safe zone.
What if Trading in Indirect Currency Pair ?
Okay, this is a bit more complicated than the example above. But only a little.
For those of you who don’t know, what is meant by indirect currency pair is the currency pair whose currency counter is in addition to USD. Examples are USD / JPY, USD / CHF and USD / CAD.
The value per pip for the currency pair is not $ 1. For example for USD / JPY: the value per pip is 100 JPY (to quote 3 decimal places). Now, to be able to enter this value into the calculation as above, you need to convert it to USD.
Return to Jasmine. For example, with the exact same scheme as the case above, he made a USD / JPY Sell transaction at a price of 120,000. He found that technically the stop loss was at the level of 120,500, which is 500 pips.
We already know that for USD / JPY, 1 pip = 100 JPY. This means that the amount of stop loss this time is 50,000 JPY. How much is that USD?
When the price touches the stop loss level (120,500), then 50,000 JPY will be worth approximately $ 414.94. How to calculate it like this: 50,000/120.5 = 414.94
Thus, the number of lots that George can open for transactions in USD / JPY are: $500/$414.94 = 1.2 Lot
Note that all of the above calculation examples do not accommodate transaction fees such as commissions or swaps (if any).
The Bottom Line
Questions like “How many lots can I trade?” Is a question I often receive during my career as an analyst and educator at several forex brokers.
Many think that they can “bomb the market” with “giant” lots, without realizing that what they are doing is just a waste of capital that actually increases the risk they face.
With knowledge of position sizing, it is hoped that you will be able to put capital right and efficiently.