Traders need to consider their position size more than their entry and exit points when day trading foreign exchange (forex) rates. Your forex strategy can be the best in the world, but if you take on too much or too little risk, you will either lose or gain money.
It is also possible to lose a trading account quickly if you risk too much. Buying or selling lots determines the size of your position:
- Currency micro lots consist of 1,000 units
- A mini lot consists of 10,000 units
- The standard lot size is 100,000 units
Your risk can fall into two categories – trade risk and account risk. To determine your ideal position size, you must consider all these elements, regardless of market conditions, trade setups, or trading strategies.
Set your account risk limit per trade
Determine the size of a forex position, which is the most important step. Determine how much you are willing to risk per trade in terms of percentages or dollars. Using the 1% limit, you could, for example, risk $100 per trade if you have a $10,000 trading account. Risking $50 per trade is within your risk limit of 0.5%. Your maximum percentage and account size determine your dollar limit. For every trade you make, you use this limit as a guideline.
Plan for pip risk on a trade
Knowing your maximum account risk for each trade allows you to concentrate on the trade at hand. Every trade is at risk based on the difference between the entry and stop-loss points. “Pips,” or percentages in points, are the smallest changes in a currency price.
One pip equals one-hundredth of one percent for most currency pairs. In Japanese yen pairs, a pip is equal to 1 percentage point. Prices sometimes appear with one extra decimal place by some brokers. An eight-digit decimal place is known as a pipette (or yen for three).
Stop-loss orders serve to close out trades upon loss. This is how you ensure that your loss is within your account risk loss, and your pip risk also determines its location. For example, if you buy EUR/USD at $1.2151 with a stop-loss of $1.2141, you risk ten pips.
Volatility and strategy determine pip risk. Risks can vary from five pips to 15 pips in a trade.
Determine position size for a trade
To calculate the ideal position size, use the formula below:
Pips at risk * pip value * lots traded = amount at risk
Using the formula above, the position size is the number of lots traded.
Consider an account with $10,000 at risk of 1% per trade. You can therefore risk a maximum of $100 per trade.
A trader buys EUR/USD at $1.3051 with a stop loss of $1.3041. It’s a risk of 10 pips ($1.3051 – $1.3041 = $0.001). Each pip movement costs $1 since you are trading in mini lots.
This formula gives you the following:
10 * $1 * lots traded = $100
Taking both sides of the equation and dividing them by $10 gives us the following:
Lots traded = 10
There is no difference between buying ten mini lots and one standard lot since ten minis are equal to one.
For example, let’s say you buy at $0.9804 and place a stop loss at $0.9794 when you are trading mini lots of the EUR/GBP. There is a risk of 10 pips again.
10 * $1.22 * lots traded = $100
Section three includes the conversion formula that gives us $1.22. Exchange rates between the dollar and the British pound may affect this number. The following is the result if both sides of the equation are divided by $12.20:
Lots traded = 8.19
This trade requires a position size of eight mini lots and one micro lot. This formula and the 1% rule will help you calculate the position and lot size for your forex trades.
Bottom line
Think about both your entry point and your stop-loss location when you make a trade. Ideally, your stop-loss should be as close as possible to your entry point but not too close that it stops the trade before you see the move you’re anticipating.
Based on the lot size, you calculate the pip value based on the distance between your entry point and your stop loss in pips.
